Mexico - a Worrying Time for Pemex

Pemex  would complicate exploration efforts this year and almost certainly put the targeted 15% increase in crude production out of reach.

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There has been widespread speculation that the recent collapse in international oil prices resulting from the breakdown of an agreement on crude production between the Organization of Oil Exporting Countries (Opec) and Russia would prompt international credit rating agencies to downgrade Pemex’s credit rating. Pemex is currently the most indebted oil firm in the world and the and the lower oil prices could affect its ability to service these debts. Fitch Ratings downgraded Pemex’s bonds to ‘junk’ status last year, while the other main ratings agencies have the firm on the brink of a downgrade.

Pemex’s credit rating is particularly important because additional downgrades could force some investors (for example, those who are either required to hold investment-grade securities, or those who simply prefer less-risky debt) to sell Pemex’s bonds, which in turn would further complicate the firm’s financial position. Although Pemex issued US$5bn in bonds in January to shore up its finances, given the recent market turbulence due to the coronavirus (Covid-19) pandemic, it may prove difficult to tap international capital markets in the coming months.

Future exploration is uncertain

The problem is that a deterioration in Pemex’s financial position is also likely to hamper its ability to explore new oil wells, as well as bring new deposits on-stream. It is not an entirely negative picture, with some of the work undertaken last year to try to improve Pemex’s finances beginning to wield concrete results.

The government led by President Andrés Manuel López Obrador envisaged that production would start or increase at nine of 20 targeted fields in the fourth quarter of 2019; there were delays in some of these, but five fields did come onstream, a sixth started production in mid-February, and the other two are expected to do so in coming weeks. These developments will help offset the natural decline in crude production in some older Pemex wells.

However, it remains highly unclear whether drilling will start in the 60 wells targeted for exploration by the government in 2020. Given the volatile oil price backdrop, with Mexico’s crude export prices dropping from US$46 per barrel (/b) in mid-February to US$24/b in mid-March, it is uncertain whether any significant new exploration will take place with prices at such low levels.

Lower oil prices will hamper private investment

Oil price developments may also have negative implications for already-strained relations between the López Obrador government and private-sector oil companies. Private firms that won stakes in the series of oil auctions that took place under the previous Enrique Peña Nieto administration (2012-2018) have been under significant pressure from the López Obrador government, to increase investment (and thus production). But these firms are likely to be revising their budgets downwards following the oil price slump and may well put exploration plans in Mexico on hold until crude prices recover.

The government was expected to launch a new energy sector plan in the coming days, with speculation about that it might extend an olive branch to private-sector energy firms in a bid to attract investment. However, even if the government does unveil such a plan, it is unlikely in the current economic environment that any oil firm would be looking to accelerate investment in new fields, particularly given broader concerns about oversupply in the world oil market. In this context, Pemex's target of increasing oil output by nearly 15% between the end of 2019 (when production stood at 1.66m barrels per day) and the end of 2020 appears extremely optimistic.

Oil hedge will help insulate the public finances

In terms of the national budget, the government is at least protected by the recent fall in oil prices by hedging agreements. At the end of 2019, the authorities announced that they had completed their US$1.15bn oil hedging programme, which hedged an undisclosed quantity of oil exports at US$49/b. The government has often used hedging options, which involve the purchase of put options (market instruments that allow Mexico to sell oil at a particular price).

If average oil prices end up being higher than the hedging price, then the buyer (Mexico, in this instance) simply lets the options expire. But if the oil price falls below the hedging price, the buyer can choose to activate the options. This provides in effect a kind of insurance against the risk of oil price dips. Although the purchase of put options in the first place costs the government money, they provide the assurance of covering budgeted oil income targets.

Mexico’s finance minister, Arturo Herrera, has said that the hedging programme in effects “shields” Pemex and the Mexican government from the effects of oil price volatility. Seeking to ease the concerns that the fall in the price of oil and the depreciation of the peso due to Covid-19 fears could undermine Mexico’s financial position, Herrera said that public finances are in good stead thanks to the actions taken by the government. In particular, Herrera noted that currently 78% of Mexico’s public debt is in pesos while the interest rates for 81% of the debt is fixed. Herrera also noted that Mexico has access to “extraordinarily large” credit lines with multilateral organisations such as the International Monetary Fund and the US Treasury that would help it “weather any storm”.

On 12 March Pemex announced that it had received the first payment from its oil price hedging programme. In a statement, the firm explained that the programme came into effect on 1 February and that the firm has now received a first payment for that month. The statement added that the hedging programme would help to shore up the firm’s finances, while pointing out that it also has access to US$7.85bn in credit lines to ensure that it meets all its financial obligations.

However, not everyone agrees that the oil price hedge is enough to “save” Pemex’s finances. Paul Alejandro Sánchez, the director of local NGO Ombdusman Energía México dedicated to promoting the development of an efficient energy sector, says that the hedging programme only covers between 30% and 50% of Pemex’s oil production; and notes that if oil prices remain below US$49/b for too long the company will invariably incur losses.

In addition, Sánchez pointed out that there is lag in the delivery of hedging programme payments, which means that Pemex may encounter cash flow problems in the short term. “There is some cash flow that will not be recovered. What does this mean? It means that the hedging payments will be paid later in the year and right there is a problem because oil will not be sold at a sustainable price for Pemex’s finances”, Sánchez explained.

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