MEXICO, PEMEX AND OIL INDUSTRY
The Mexico of Lopez Obrador and the "energetic sovereignty"
When Manuel Lopez Obrador was elected president of Mexico about two years ago with the left-wing civic movement Morena, his opponents feared the specter that the country could have followed in the footsteps of Venezuela and Bolivia, comparing Amlo (as he is called by the Mexicans) to Chavez and Morales. At that time it seemed a distant danger, because the great Latin American country was said to have a different geopolitical and economic structure with respect to the countries mentioned and this would have precluded any possible risk of an excessively populistic drift. Expectations were high, equal to the pronouncements of the new president who aimed to defeat corruption and social inequalities through the redemption of the poorest part of the country. These are intentions already heard many times, especially in the Latin American world: for this reason, now more than ever public opinion needs to verify that words are followed by concrete actions.
The coronavirus could have been a great test, but the scarce and antithetical answers compared to those provided by the rest of the world have started to question the results of the presidential work in these two years of leadership in Mexico.
The president's belief relies on the struggle against neoliberalism and consequently his political idea embodies the existence of a state-centered economic model, with all activities centralized, dependent on national production and without any influence from abroad: basically, a refusal of international investors. This project is called "Fourth Transformation", that is, the rejection of free market policies that had opened the country to international trade and investments, culminating in the 1994 NAFTA agreement with the United States and Canada.
One of the cornerstones of this socio-political agenda is the oil market (Mexico represents one of the main producers), and specifically the pursuit of a new state energy sovereignty in order to regain full control over the production and refinery of crude oil. But the plan to achieve this goal relies on two aspects: the incongruity to reinforce Petroleos Mexicanos (Pemex), the state-owned company de facto monopolist in the Mexican energy market, which is financially and economically a major problem; a strategy only focused on increasing production, a struggle for the restoration of a lost national pride, despite the use of logic and business considerations would recommend the opposite.
Pemex
Pemex was established in 1938 when the then president Lázaro Cárdenas decided to nationalize Mexico's oil market by expropriating the American and British companies' assets: he created a monopoly regime for the crude oil drilling and distribution. Pemex is state-owned and, in order to understand what that corporation represents in Amlo's political propaganda, he added the motto "Por el rescate de la soberanía" (For the rescue of sovereignty) to the company's logo as soon as he was elected president.
1) Pemex debts
Pemex is the most indebted oil company in the world with 104 billion US dollars (in 2008 there were just 36) (fig. 1).
In order to cope with this financial burden, which prevents any profits from being reinvested, the Mexican government put $ 5 billion into the company in 2019. In the same year, Pemex issued three 7, 10 and 30-year maturity bonds to pay off part of the debt represented by securities: that liquidity was not intended to be used in the company's operations but to refinance some bonds with a maturity between 2020 and 2023, with the target to only extend the debt's duration.
The downgrading on Pemex by the major credit rating agencies (S&P, Moody's, Fitch), now dangerously close to "junk bonds", represents a further weakening on the company's financial position: in fact, to ensure that the securities are picked by the investors, Pemex must provide high yield appropriate to the big risk that a buyer bears by purchasing this type bonds. Thus, growing financing costs, starting from 2020 when $ 6 billion in bonds will have to be renewed. But the most worrying situation should be occurred in 2024 when about $ 60 billion in bonds will expire and they will have to be paid off and if possible to be refinanced at the same time: without financial improvements and without guarantees about the corporation's economic health, there is no way to predict at what rates and for what amount the market will be willing to buy the oil company's securities. An important, actually crucial, aspect for the entire Mexican economic system resides in the fact that essentially Pemex bonds can be assimilated to public debt being the Mexican Government the firm's owner. A company's crisis on the capital market would automatically result in a major problem for Mexico as a sovereign state.
In an attempt to raise the fortunes of company and to improve the economic performance, the Mexican Government has declared a cut on profit-sharing tax of about 7 billion dollars for the next two years. This would be good news from the business side, because the fiscal level was actually unsustainable. But the fact is that Pemex alone represents one fifth of Mexican tax revenues (compared to an incidence of only 3.4% on the country's GDP). The Mexican fiscal and financial authorities are therefore faced with the anomaly of a company that, in order to make profits, must obtain a reduction in the tax burden, which in turn decreases State revenues just when the Government needs support Pemex with the introduction of public money: in short, the well-known and long-standing problem of state-owned companies.
2) Pemex losses
In the first nine months of 2019, the company suffered losses for 176 billion pesos, when in September 2018 they amounted to 23 billion pesos. The loss, as from the SEC authority's report, originated from: a) a decrease in total sales mainly due to a drop in prices of gasoline and diesel as well as a decrease in the volume of Mexican crude oil exports; b) a decrease in foreign exchange gain due to the lower appreciation of the peso against the US dollar;
c) increase in operating expenses; d) increase in financing costs and in derivative financial instruments.
The losses occurred in 2019 with an average oil price per barrel of $ 60, almost four times more than current prices.
The losses occurred in 2019 with an average oil price per barrel of $ 60, almost four times more than current prices.
3) Pemex production
In addition to financial debt and losses, another declining indicator is total sales, which dropped 16% in 2019 to $ 74.3 billion, both crude exports and domestic sales.
Currently Pemex produces just over one million seven hundred thousand barrels per day, half of the 3.4 million in 2004 and 7% less than 2018 (fig. 2).
According to the president's ambitious plan, Mexico is expected to produce 2.6 million barrels per day by the end of his mandate (in 2024), through the plan to drill new wells at 20 new fields (fig. 3 which shows as the increase on production only relies on new explorations), a hypothesis deemed extremely optimistic by all oil industry analysts. In fact, those new wells are too small to compensate for the losses of the larger ones (they have less than 50 million barrels of recoverable reserves): currently the famous Cantarell field is almost exhausted and the Ku-Maloob-Zaap field is decreasing at a faster pace than expected. In addition, those new fields have big technical challenges.
Given the lack of international investments, it seems very hard to keep pursuing such an expansion policy. For ideological reasons, Amlo disregarded the 2013 energy reform that opened Pemex and the Mexican oil market to foreign companies. One of the president's first policy moves was to promptly cancel the competitive oil rounds where foreign producers were able to participate, and blocked Pemex from finding new partners to help develop existing projects; thus, vowing to resurrect sinking domestic oil production through greater domestic involvement.
The Italian Eni, one of the first to take advantage of the openings in 2013, still operates with eight licenses in the Gulf of Mexico (indeed, just in February it announced a new oil discovery), but with raising concerns about the risk that Amlo could suddenly change things:
Actually, Eni would already seem to have considered this event when it sold 35% of the equity investment in the so-called Area 1 to Qatar Petroleum (it acquired the license in 2015)
https://www.eni.com/it-IT/media/comunicati- press / 2019/07 / eni-starts-production-from-area-1-in-offshore-del-mexico.html . It is an agreement which might sound like a protection against the possibility that the Mexican Government may restrict the foreign companies' sphere of action at any time.
The autarchic and ideological closing to international investments appears to be a kind of own goal for the expansion of the Mexican oil market, because Pemex does not seem to have the technological and financial resources to support the government's ambitious plans.
For example, the unconventional oil market, the so-called shale oil https://argomenti.ilsole24ore.com/parolechiave/shale-oil.html, has represented the U.S. energy revolution (they are net oil exporters in this sector), by allowing its oil independence in geopolitical difficult times. The boom in this production, especially in Texas and North Dakota, has attracted huge investments in recent years; and the predictions made in the past that financial and engineering issues would likely affected this sector are not proving to be true, mainly for the industry's ability to cut costs along the supply chain. Mexico has the same reserves as United States, especially in the north of the country. In order to exploit them it is necessary to use particular techniques such as hydraulic fracturing (known as fracking). López Obrador has forbidden the use of fracking as he considers it dangerous, actually hiding the real motivation: Pemex does not have the means to pump the shale to the surface and not even the appropriate financial resources (the rate of decline of wells by using fracking is higher compared to traditional drilling, which means a faster need for new explorations and therefore more investment). In order to use this enormous underground potential, it should rely on foreign companies equipped with the suitable technology and to international investors: but it is something that Mexico, in the name of the centrality of Pemex, has no intention of doing at the moment.
4) Pemex productivity
The productivity of Pemex is very low: 15 barrels per day per employee. Petrobras, the Brazilian state-owned company and main competitor in Latin America, produces 30 barrels per employee (not to mention, it produces a 10% higher revenue with half of Pemex's workers).
One of two: either the number of workers should be reduced or the existing ones should be forced to work more and better. In all cases, the resulting social impact would be to be verified.
5) Pemex oil prices
The president's social policy on petrol price would prefigure its low level to enhance consumers' income. In its annual budget for 2020, Mexico had predicted a price of $ 49 a barrel, which was the basis for Pemex's revenue forecast for the current year.
Later, prices began to collapse in 2020, and the Mexican mix (the price of Mexican oil is a mix of international prices) reached around $ 16 a barrel on April 9, after a minimum of 10,37 dollars in late March and the year's higher level at $ 59. A Citibanamex analysis estimates an average of $ 22 a barrel for 2020. Since extracting a barrel of oil costs approximately $ 24, at current price levels it would seem perfectly uneconomic to do so; unless closing some production fields, as the Financial Times suggests, because at present-day prices nearly 75% of them will only generate losses. Therefore, the circumstances would require a change in strategies, based on a reduction in activities.
But Mexico, as showed at the OPEC + meeting which was organized to decide a production cut to support prices, continues to follow its plan of production growth despite a collapse on oil's demand of 30 million barrels a day since the beginning of the year; a strategy scheduled to achieve the energy independence which is the main goal of López Obrador, focused on the output with little interest for financial results.
One of the explanations of Mexican intransigence to an increase in prices could be entirely financial: at the beginning of the year, Mexico negotiated a derivative, in the form of a put option, which hedges it from downward price fluctuations. It is a strategy the Mexican Government is using for 20 years, and therefore it is not a current president insight. it is a very expensive financial instruments, because it costs over one billion dollars (as can be seen in the past year's income statement). It is basically a bet and behaves like an insurance policy: when the market price of the underlying asset drops below a certain pre-determined level within a specified time frame, the owner has the right to sell the amount indicated at the price set out in the contract.
Since the transaction is covered by state secrecy, it is assumed that the price below which the gain is triggered may be $ 45. If prices remain at their current levels until the end of November, the average would be approximately at $ 20 per barrel, and according to Bloomberg agency calculations, Mexico would collect about $ 6 billion. Government representatives confirm neither the existence of the operation nor the terms. Hedging obviously makes the low price situation less desperate for Mexico, but it's still a bet you can win or lose. But nevertheless, beyond the financial techniques that are inherited from previous governments, the great reason for the stubborn defense of a high oil production precisely relies on the will to pursue the primary objective of Amlo's energy policy by all means: bringing Pemex back to old glory reverting to the productive levels of the past, against all possible economic and business consideration, and beyond reason and logic.
6 ) Mexican oil refineries
López Obrador's plan would be to refine within the Mexico all oil extracted. In order to do this, he is strongly investing not only in the renovation of the six existing refineries, but in the construction of a new one in Dos Bocas, at the State of Tabasco (his State).
The project, to be completed by 2023, will cost $ 8 billion. According to the major oil industry analysts, it appears oversized compared to actual Mexican crude oil output; moreover, according to studies concerning the construction of other similar refineries, it might cost more than the budget.
Aside from the impact of this investment on public finances and the real return in terms of new jobs, the environmental issue is having great prominence.
Major environmental associations (including Greenpeace) complain that the project will result in the destruction of mangrove tree forests (in those areas there is the fourth largest area of mangroves in the world), which are considered as "sentinels" of the ecosystem because of the protection they assure against carbon dioxide, storms and floods.
It is incongrous that just ten years ago Pemex executives believed to transform that site in a protected natural area.
This happened before the Mexican president started his "energy sovereignty" program, focusing on the production in order to revert to the past, without paying attention on financial, economical and social implications which, actually, may decide if a corporation can be profitably competing on the market.
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