Politics Make Strange Bedfellows

It’s been just over a month since Andres Manuel Lopez Obrador secured his landslide victory over Ricardo Anaya to capture the Presidency of Mexico. A damning indictment of establishment politicians, AMLO’s win signaled a new era for Mexican politics, and the far left candidate has wasted no time in casting his vision for the country’s future. Having campaigned on a platform of radical change, it comes as no surprise that AMLO intends to abandon the course laid out by his soon-to-be predecessor, President Pena Nieto—and in the past week, the President-Elect has issued several announcements regarding his intentions for the country’s energy sector. Get the latest in this issue of Market Update.

 

A Friendship of Convenience

In sharp contrast to the anti-Trump vitriol of his campaign, AMLO has so far forged a rather amiable relationship with the American President. In light of the current political climate, however, the development isn’t quite as surprising as you might think. Cooperation is politically expedient for both parties in the near term, as Mexico and the US want to put NAFTA renegotiations to bed by the end of the year.

Rightly, both leaders see the renegotiation process as causing unwelcome jitters in financial markets. AMLO recently wrote to Trump and stated that “prolonging the uncertainty could slow down investments in the medium- and long-term.” It sounds an awful lot like AMLO wants to leave the credit or the blame to the outgoing administration. Meanwhile, President Trump wants to claim victory over his promise to fix or ditch NAFTA by the midterms.

While the two leaders agree on the importance of stemming illegal immigration to the US, they do so for very different reasons. President Trump wants strong borders as a matter of security and to protect employment for US citizens. To do that, he needs Mexico to intensify its efforts to prevent migrants from pouring through our southern border. It’s a job AMLO hopes to solve on the supply side. Having campaigned on a message of domestic job creation and educational opportunity, AMLO hopes that a stronger Mexico will reduce the need for its citizens to search for work elsewhere.

Finally, during Mexico’s lame duck Presidential period and the run-up to the US midterm elections, neither leader wants to rock the boat. Both countries need stable financial markets and an optimistic outlook for their parties to succeed.

In the long term, the current coziness between AMLO and Trump is unlikely to last. President Trump firmly believes in strong borders and an America-first economic model. On the flipside, AMLO rode a wave of discontent with the existing ruling party and anti-Trump rhetoric to a Presidential victory. The Mexican population will never trust President Trump or any Mexican president who appeases him. The coming months may see the sides engage and work together for small victories aimed at building credibility and stockpiling political capital, but the fundamental platforms that carried the elections simply won’t allow either side to pursue their objectives cohesively.

 

Show Me The Money!

AMLO has stated that his administration will allocate nearly $10 billion in 2019 to revitalize Mexico’s energy sector. These funds will be put toward four strategic projects:

  1. Increase the country’s extraction of oil and gas “with urgency”
  2. Rehab Pemex’s existing six oil refineries
  3. Construct a seventh refinery in Dos Bocas, Tabasco
  4. “Produce more electricity”

Upstream, the plan calls for an additional $4 billion in E&P investment. Production in the country has plummeted since peaking at 3.4 million bpd in 2004, and today sits at just 1.86 million bpd. AMLO will seek to raise that number to 2.5 million bpd.

AMLO’s second goal is to revitalize the country’s refining capabilities. To that end, AMLO will allocate $2.64 billion over two years for the rehabilitation of Mexico’s six refineries, and an additional $8.63 billion over three years for the construction of the Dos Bocas refinery in Tabasco.

Through the refinery upgrade plan, AMLO said his government would aim to raise utilization rates to 100 percent, up from 40 percent. It’s an ambitious (read: totally unrealistic) goal given maintenance and turnarounds. To put it in perspective, the current utilization rate for US refiners last April was just 92 percent.

As to the fourth and final project, AMLO plans to modernize and strengthen CFE power plants that were scheduled for closing, starting with hydroelectric plants to the tune of $1 billion over one year.

Individually these project are enormous undertakings that require capital, technical expertise, skilled labor and considerable amounts of time. Tackling all four simultaneously is a bold move for a company on the brink of financial ruin.

Industry professionals point out the biggest challenge is the lack of capital. With crude production plummeting, there simply isn’t any cash generation to fund the spend. Add to that the fact that rates are increasing and Pemex’s balance sheets are stretched to the max, and Mexico is going to find it increasingly difficult (and expensive) to access global capital markets.

A second risk is the proposed reversion of Pemex’s fuel pricing policy. AMLO has promised that gasoline prices will not rise. Given the current lack of domestic production, fixed pricing for fuels would kill the economics on imports.

AMLO has also threatened to suspend scheduled bidding processes for upstream acreage and operating interests in licenses currently held by Pemex. If Pemex doesn’t have the money (not to mention the technical knowhow) to ambitiously drill for new production, kicking the international community out of the country will only further dampen the finances available from crude production.

“I believe that that is going to be the actual red line for this administration,” Gonzalo Monroy, founder of the energy consultancy GMEC in Mexico City, said. “If Mexico is downgraded to the point of losing its investment grade, then all bets are off.”

Pemex reported a net loss of $8.2 billion for the second quarter, compared with a $1.77 billion profit in the same period a year ago. Pemex needs this administration to navigate “con cuidado.” Cash is limited, credit is stretched thin and the international community is skeptical. Good intentions need to be balanced with good sense.

 

Formalized Appointments

As expected, President-Elect AMLO has announced several key personnel for his administration including Rocío Nahle to serve as Minister of Energy and Octavio Romero Oropeza as Director General of Pemex.

With a degree in chemical engineering and a petrochemical specialization from the Autonomous University of Zacatecas, Nahle made her career working in PEMEX’s petrochemical complexes in Cangrejera, Pajaritos, and Morelos, where her roles included process engineering at industrial plants, quality control and analysis, as well as management and finance.

Nahle previously ran for the upcoming 64th legislature and won a senate seat. She is a member of the Latin-American Parliament (Parlatino) of the Mexican Senate’s Energy Commission, acted as a legislative adviser in the Chamber of Deputies for the 59th and 61st legislatures, as well as the Senate’s 62nd legislature. Nahle also participated in the debates surrounding the 2008 and 2013 Energy Reforms.

Romero Oropeza, on the other hand, has no prior experience in oil and gas. For a career politician with a degree in agronomy, turning around a beleaguered oil company won’t be easy. Romero, who replaces Carlos Trevino, will inherit a mountain of debt, more than $100 billion, and a domestic E&P environment that is in utter free fall. Pemex pumped 1.866 million bpd during the second quarter of 2018, its 13th consecutive decline when compared to the same period in previous years.

Perhaps unsurprisingly, the current environment has many in oil and gas concerned about the future viability of the Mexican market. But the numbers don’t lie, and at least for the foreseeable future, Mexico will continue to rely on foreign product to meet demand.

What are you thinking about Mexico? We’d love to hear from you. Click here to contact our international markets team.

 

Best,

Chad Smith
Senior Vice President of Terminal Services