Tectonic shifts and clouds of uncertainty after Sunday’s election.
By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.
Since the election on July 1 of veteran leftist politician Andres Manuel Lopez Obrador (AMLO for short), a dark cloud of uncertainty has gathered over the future of Mexico’s oil industry, which was already in dire enough straits. After decades of chronic mismanagement, unfettered corruption, and declining oil reserves, Mexico’s state-owned oil empire, Petroleos de Mexico (Pemex), once the world’s third largest oil producer, excels in only two areas: accumulating massive losses — both in money and stolen oil — and clocking up new record levels of debt.
Now, there are fears among investors, both domestic and foreign, that AMLO could reverse his predecessor Enrique Peña Nieto’s energy reforms, which reopened the oil and gas sector to foreign investors, ending Pemex’s monopoly after almost eight decades.
On the campaign trail, AMLO repeatedly pledged to suspend new oil auctions and review contracts issued to private energy firms for signs of corruption. Given those contracts were drawn up by the Mexican government and Pemex, two institutions that are riddled with corruption, as well as some of the world’s biggest oil majors, those signs shouldn’t be hard to find.
Since then, the president-elect’s senior finance official, Carlos Urzua, has tried to mollify fears by clarifying that the AMLO government was not planning on pursuing major legislative overhauls of the oil sector. But not everyone’s convinced.
On Monday, Moody’s warned that AMLO’s election would lead to short-term market volatility and represented risks for the oil sector. Fitch Ratings echoed those claims, cautioning that the election would bring prolonged uncertainty. Cancelling multi-billion dollar oil and gas contracts is also likely to put AMLO’s government on collision course with some very important oil majors and global investors. According to the Mexican daily El Excelsior, the contracts signed to date alone represent a projected investment of around $200 billion dollars.
With AMLO scheduled to take the reins of government in December, Pemex is frantically accelerating its farm-out program. It hopes to choose new partners in at least seven onshore oil fields later this year, as well as make an announcement in late July on three refinery joint-venture agreements.
But attracting investors in the current climate of uncertainty may be more difficult than it was. Lopez Obrador propounds a more nationalistic energy strategy than the current government, raising fears of messy, costly expropriations. AMLO’s party, Morena, will have control not just of Mexico’s executive branch, but also the nation’s Congress and Senate. While there are certain regulatory safeguards in place to minimize the risk of excessive government interference, they could be changed with a simple majority in Congress.
AMLO has also said he may temporarily freeze gasoline prices, which have soared in the last year and a half following the deeply unpopular withdrawal of government subsidies in the famed gasolinazo of January 2017. He has also proposed building two new refineries at a cost of billions of dollars each.
Paying for such measures will not be easy, however, especially given Pemex’s precarious financial condition. Over the past several years, the shrinking oil giant has failed to stem long-term production declines, reverse refinery losses and has continually piled on fresh debt. In the last five years alone Pemex’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 be worth an additional 9% of GDP.
All the while, the company’s output continues to flag. Between 2016 and 2017, its production of crude oil slid 9.5%, from 2.15 million barrels per day (bpd) to 1.95 million bpd, its lowest level since 1980. By March it has slipped further, to 1.87 million bpd. Its average daily level of natural gas extraction also fell 12.5% to 5.06 billion cubic feet per day.
Trying to raise investment as Pemex’s losses and debt pile up while its output continues to fall will be no mean feat, particularly if Pemex’s deteriorating health begins to take a toll on the cost of issuing new debt for Mexico’s government. Given its oversized dependence on public funds, Pemex’s future is more tightly interlinked with Mexico’s government than it has been for a long time.
As Fitch notes, Pemex’s credit rating is the same level as Mexico’s sovereign debt rating, since they are both highly dependent on one another, although Pemex’s contribution to state coffers has shrunk by around half in the last decade. As such, the Mexican government has a very strong incentive to continue supporting Pemex, given the severe consequences the company’s deteriorating health could have on the country’s economy.
The stark reality, when it comes to Mexico’s struggling oil industry, is that AMLO’s hands are already more-or-less tied before he even takes power. If he adopts too radical an approach, he risks scaring off footloose foreign money and the cost of debt, both for Pemex and Mexico’s government, could surge.
Pemex’s predicament is a result of a dizzying array of factors that are years, if not decades, in the making. They include bad management, severe budget cuts, shrinking oil reserves, lack of investment resulting in poor or obsolete infrastructure, negligence, systemic oil theft from criminal gangs helped by Pemex employees, and the huge tax burdens the government imposed on the firm in the years preceding Mexico’s oil reforms, while lavishing foreign companies with massive fiscal incentives to invest in Mexican oil fields. That’s not to mention the rampant corruption that infects many levels of the organization.
Just trying to reverse any one of these deeply debilitating trends will be a gargantuan task, in particular with regard to the last one. AMLO ran on a strong anti-corruption ticket, and if his government were to begin addressing the systemic corruption and culture of impunity that have bled Pemex dry while filling the pockets of crooked contractors, executives, unions, and politicians, then perhaps Pemex, and by extension Mexico as a whole, may have a somewhat brighter future. But it’s a big “IF”. By Don Quijones.
Just as the gasoline market is opened to competition, Mexico becomes one of the worst places in the world for fuel theft. Read… Petro-Plunder Rages in Mexico, Costs Surge
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I have lived in Mexico and have relatives who, for the moment, are still down there. The corruption is endemic and EVERY politician promises to stop it…until they are elected and they start collecting the bribes. Then things go back to normal, just different hands stealing.
+1. Not sure what people expect out of this. Quoting from the article: “veteran leftist politician Andres Manuel Lopez Obrador”. A veteran politician means people already know his dirty laundries, otherwise why is he still alive and kicking?
Sounds like AMLO’s days are numbered.
Hi DQ, which financial institutions are owed the 106 billion dollars. Regards Steve
Hi Steve,
Much of that debt is owed to bondholders. To my knowledge, the banks that have lent the most to Pemex are the three homegrown development banks that extended Pemex an €850 million life-line when the oil company’s financial woes came to a head in 2016. Those banks are Banobras, Bancomext and Nafinsa. Of the three, Banobras is most exposed, with dibs on over half the debt.
After the deal was struck Moody’s warned that the loan would significantly increase the three banks’ combined exposure to Pemex’s debt from 44% to 62%. Here’s an article I wrote on the subject at the time:
https://wolfstreet.com/2016/03/16/big-oil-bailout-begins-as-pemexs-debt-spiral-deepens/
Your retirement fund :-]
The Fidelity “Corporate Bond Fund” is among the stakeholders. In fact, PEMEX is a top 5 holding for FCBFX:
https://fundresearch.fidelity.com/mutual-funds/composition/316146596
If PEMEX blows up, it’s going to be a surprise to a lot of folks – just like when a bunch of Muni bond investors had no idea they were exposed to Puerto Rico until it blew up.
Mexico — along w/ Argentina, Venezuela, Syria, Egypt and others — are poster children for Peak Oil.
The Giant Countries like USA & China are relatively unaffected while the little countries on the margin are whacked.
I bet you Singapore will not be affected either and it’s an even smaller country.
There’s a reason why stereotypes work.
I would think the US will ultimately be the worst effected unless of course people can actually wake up and stop wasting so much energy My guess is reality will force it on us
Steve,
Your comment reminds me of a documentary I saw years ago about the Great Depression. In it they described how Americans were suffering but also went into detail about the impact the depression had on certain small countries, ones that only had a single export or two that kept their economy afloat. I don’t remember the commodity, but they highlighted a Latin American country whose GDP completely flattened when the demand for that commodity evaporated. We are by nature egocentric. But when things go badly here, it can be devastating to a small, commodity-exporting country out yonder.
DQ, what’s the odds of Mexico becoming a failed state within the next decade, either that or a narco state controlled by the drug lords? With it’s continued financial decline how could it not eventually collapse?
Isn’t it a “failed state “ NOW? Guess it depends on your definition
I’m somewhat hopeful that an outsider (not PRI or PAN) from the left might be what they need. In my view, Mexico’s #1 problem is their tolerance for monopolies. This causes all sorts of problems including a wicked wealth divide.
The new president seems keen on the ideas of pushing wages higher and pushing more development in the south. Hopefully he can accomplish some of that when he renegotiates NAFTA with Trump.
Perhaps he can even get away with somewhat higher gas prices if he offsets the effect with subsidies for home-grown corn.
“Outsider”???? No, he is not an outsider, just analyse his background and the people he is working with…… It is the same thing.
Mike,
To a certain degree Mexico already is a narco state. Their power is arguably greater than ever. 2017 was Mexico’s most violent year on record and the violence has even spread to parts of the country that were for a long time much more stable and peaceful, such as Puebla, Quintana Roo and the capital, Mexico City. That, together with the rampant corruption of government and business and the rising inequality, was the reason why so many voters, including many middle class ones, voted for a left-wing nationalist like AMLO.
As to whether Mexico will become a failed state, I would say the odds are still pretty slim. A failed state is an extremely high bar to reach. In effect, you need the whole political system to collapse, leaving a huge power vacuum in its place. Mexico has a very long way to go before reaching that stage, although a few of the country’s most violent states (Michoacan, Guerrero) could be said to be failing.
It cannot be in the best interests of the U.S. for Mexico to collapse even partially as that would turn the trickle of illegal immigrants into a flood. That’s why I don’t understand Trump, it’s like he’s deliberately trying to destroy Mexico.
The logical thing would be to try to strengthen Mexico to help stave off any collapse, like encouraging American multinationals to transfer their manufacturing from China (and other cheap labor nations) to Mexico to help strengthen its economy. Of course, logic is not something this particular administration is strong on.
I hope you’re right about it not being close to a failed state, but I do know that things can spiral out of control very fast sometimes when enough problems accumulate.
What Mexico needs above all else are higher real wages, including for cops, so people can make a living doing their regular jobs. Of course, Corporate America, Japan Inc., Deutschland AG etc. are all looking for cheap labor, and they’re making deals with politicians and unions in Mexico to keep wages low in return for an investment. This is one of the biggest failures of NAFTA, which was supposed to raise wages in Mexico as a side effect, but never did.
And once all banks move to use fingerprints and all that, all that money will just get stolen.
Yeah Mexico has a brig future ahead!