“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 tothe 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 toinformation 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.