Spring Broke?

 

It’s Spring Break here in San Antonio and as the kids say, “Sun’s Out, Guns Out.” Ok ok, maybe that shouldn’t be this week’s slogan given the rash of violence that continues to plague Mexico. Regardless, spring is upon us and Mexico still represents the biggest opportunity going in the global energy trade. Keep reading to get a closer look at AMLO’s downstream energy policy and the latest financials from Pemex. Plus, find out what all this tariff talk could mean for US investors in Mexico.

 

Cocktail for Disaster

As Mexico’s presidential election draws closer, new details are shedding light on presidential hopeful Andres Manual Lopez Obrador’s proposed plan to restore Mexico’s struggling energy sector. Central to the program is a commitment to strengthening Pemex’s downstream segment. A marked departure from the current administration’s focus on drilling, AMLO’s plan would boost refinery throughput to generate more gasoline and diesel domestically, and thereby reduce the country’s reliance on global imports (notably from the US).

I won’t mince words: this is utter nonsense. The cost to modernize Mexico’s existing refineries is staggering. Ballpark estimates suggest a capital investment of $20 billion and years, if not a decade, to complete. Given Mexico’s dismal track record for completing projects on time and on budget; well, let’s just call it $30 billion and ten years. This not taking into account AMLO’s plan to build two new refineries and we have a funhouse-sized budget with a timeline that is wholly unrealistic.

Still not convinced. Let’s dig a little deeper. Imagine that the above plan was in place and functioning at optimal levels. There is still a fundamental problem with AMLO’s downstream-centric plan: Pemex production from Mexico is on the decline. Production figures in 2017 fell under 2 million bpd, and are falling at treacherous double-digit rates annually. What does it all mean? Pemex will not have the domestic crude production to supply their shiny new refineries by the time they are constructed.

Sure, Mexico could produce their own gasoline, but really they will just be swapping out purchasing refined products on the global market to relying the US, Russia or the Middle East to supply the import of crude. Spending billions to save pennies on the dollar is a losing plan. Drilling for oil is the route to riches, just ask any wildcatter.

 

Credit Hangover

The fourth quarter results for Pemex are in and they are as ugly as a South Padre hangover. The Mexican oil company reported an $18 billion loss over the last three months of 2017. OUCH!

The devaluation of the peso versus the dollar contributed substantially to the loss. How so? Pemex operating costs are in pesos, but the company buys and sells crude and refined products in dollars. The peso was down 8 percent versus the dollar, resulting in a foreign exchange loss of nearly $8 billion.

Despite the relative uptick in commodity prices, Pemex is not positioned to benefit from the recovery in prices due to their lack of production. With a total annual production under 1.9 million bpd, Pemex refining consumes the bulk of that production leaving only 0.5 million bpd to export. By contrast, the US recently removed the ban on crude exports and increased volumes from roughly 0.5 million bpd to an average of 1.2 million bpd, hitting a high in October in excess of 1.7 million bpd.

This isn’t the first round of bad financials for Pemex, and their statement of cash flows shows the pain. In 2017, Pemex paid nearly $6 billion in interest expense alone. Call that $1.5 billion per quarter or more than $16 million dollars every day paid to debt holders.

 

Making Friends

While the Trump administration continues to steer the American economy upward, reception for the President’s steel and aluminum tariff policy has been chilly at best. The plan calls for a 25 percent tariff on foreign steel imports and a 10 percent tariff on aluminum. Washington policy makers have issued a chorus of caution for the measure, echoed by international industry leaders and world heads of state.

The President sees the tariffs as an incentive for manufacturers to bring facilities and jobs back to the US, but the announcement also added stress to the already strained relationship between the US and Mexico. Given the ongoing renegotiation of NAFTA and the developing oil and gas trade, President Trump has installed a mechanism to temporarily exempt Canada and Mexico to allow for smoother negotiation. The revised policy makes sense: Canada and Mexico account for nearly a quarter of all steel imports to the US.

Across the pond, the European Union was quick to come out against the imposed tariffs, leading Trump to suggest that other countries may seek similar exemptions. Curiously, the underlying target of the tax is China, though they only ranked 11th on the list of steel imports to the US in 2017. Is this yet another bargaining chip in trade relations by President Trump or will he follow through on the tax to push his agenda?

Interested in jumping into the Mexican market? Click here to contact our international markets team.

 

Best,

Chad Smith
Senior Vice President of Terminal Services