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A Dramatic U-Turn In Mexican Oil & Gas

Nick Cunningham

Mexico may do a U-turn, and call on the private sector once again to boost oil and gas production.

Mexican President Andrés Manuel López Obrador has tried to put the brakes on the country’s historic shift towards privatization that began under his predecessor. Former President Enrique Peña Nieto pushed through a privatization plan that ended seven decades of state control over the oil sector. Pemex remained in state hands, but oil and gas exploration and production was opened up to international companies. Pemex partnered with many of them, but private companies were also allowed to take the lead.

After his election last year, AMLO tried to change course. He signaled an indefinite end to oil auctions, citing disappointing results from them private companies. He also shifted back and forth on the integrity of prior auctions, at times suggesting that they were done in a corrupt fashion.

At the same time, AMLO tried to resuscitate Pemex, proposing massive billion-dollar capital injections into the state-owned company and pushing for Pemex to return to its historic place as the dominant entity in the energy sector.

The problem for Pemex is that it has become the most indebted oil company in the world, sitting on over $100 billion in debt. It presides over aging oil fields that have been in production for decades, with output suffering from a steep decline that began in the mid-2000s. Mexico produced 1.67 million barrels per day (mb/d) in July, roughly half the total from a peak in 2004. Falling production and rising debt are a toxic mix, especially since reviving output will require ratcheting up spending. Lower oil prices over the last few years have only accelerated and magnified the financial problems at the company.

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Pemex has seen its credit rating cut by multiple credit agencies over the past year. For instance, in June, Fitch Rating slashed Pemex’s credit rating to BBB from BBB+.

Adding to the complexity is the fact that Pemex’s predicament creates problems for the Mexican government. Pemex is a huge source of revenue for the budget, but because of its declining position, the government is trying to step in and help. But any effort from the government is a drag on public finances. Tax cuts and capital injections, for instance, pose sovereign credit risks. But any decision to cut spending, which in theory would be better for the state budget, could hollow out Pemex. This is the conundrum that AMLO has been unable to find a way out of.

For instance, an expensive and questionable decision to spend more than $7 billion on a new oil refinery could simply create another white elephant. Pemex’s refineries are already loss-making, and operate below capacity. Spending billions of dollars on a new one raises red flags.

Finally, the economy is slowing as global headwinds have not spared Mexico. “Lower growth, together with changes to energy policy and the role of Pemex, introduce risks to Mexico’s medium-term fiscal outlook,” Moody’s stated in June when it cut its credit outlook for Mexico to negative. “Unpredictable policy-making is undermining investor confidence and medium-term economic prospects.” The economy did not grow in the second quarter.

Against this backdrop, AMLO is considering an about-face. The FT reports that the Mexican President is poised to allow Pemex to resume joint ventures with private companies next year, and could allow for private sector exploration offshore as well. The FT said that AMLO met with Claudio Descalzi, the CEO of ENI. The Italian oil company has had some success in oil exploration in offshore Mexico since the energy privatization law earlier this decade. The meeting highlights AMLO’s newfound interest in the role of international companies.

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The FT reports that AMLO is trying to head off another credit downgrade for Pemex. Were that to occur, the rating could fall into junk territory, which could force billions of dollars of capital from institutional investors to sell off Pemex’s debt. If Pemex is subsequently dragged down further, that in turn would create more sovereign risks.

Instead, pushing more of the burden on the private sector, the argument goes, would relieve pressure on both the Mexican state and Pemex.

“We are working with the president so farm-outs [joint-ventures] can start up in 2020,” one Mexican official told the FT. “For deepwater, it would all be for the private sector.”

Analysts believe that the decision, should it occur, would send a positive signal to international investors, especially since it follows the recent agreement to end pricing dispute over natural gas imports.

AMLO wanted to return Pemex to its 20th Century glory. But he now seems poised to turn the playbook of his predecessor.

By Nick Cunningham of Oilprice.com

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