Where the Rhetoric Meets the Road

 

In just 10 weeks, Mexico’s President-elect, Andres Manuel Lopez Obrador, will take the big seat in the world’s 11th most populous country. As we inch closer to the AMLO era, rumblings about the leftist candidate’s intentions for Mexico are shedding new light on the future of the country’s beleaguered oil and gas sector. Pemex, private investment, and the ever present need for more money—it’s all in this issue of Market Update!

 

Make Pemex Great Again

It’s been a tough decade for Mexico’s national oil company. Year over year, Pemex has seen 10 percent declines in output thanks to ongoing financial distress, outdated technology, and political interference. While contentious, 2014’s historic energy reforms have created a viable path forward in Mexico, and the country has enjoyed an influx of private investment since removing the political shackles that previously restricted foreign participation in Mexico’s energy markets.

Along with those dollars, Big Oil brought the modern equipment and processes that make it possible to extract oil in greater quantities and at a lower cost. But as part of his Presidential campaign, Lopez Obrador threatened to halt future auctions, review previously awarded contracts, and give outsiders the boot from Mexico.

Since winning the election in July, AMLO has tempered his original position, but only slightly. Contracts will be reviewed and some may get revoked or altered to benefit Pemex financially, but for the most part, these reviews should have little impact on assets that have already been awarded. I predict that drilling will proceed and production will follow.

The real question is this: Will future blocks be auctioned, and if so, who will participate and how will winners be chosen? The answers won’t be cut and dry. AMLO has hinted that there will be zero auctions under his term. Closing the doors to foreigners would turn the clock back on Mexico at least 10 years, and even if Obrador can source the funds required for exploration, Pemex lacks the competitive tools to significantly ramp up production. Not to mention how difficult financing will be, given that the Mexican oil giant is losing tens of billions of dollars annually.

Reality tells me that auctions will be put on hold until a new process can be ironed out. I expect the revised terms will be more favorable to Pemex and more restrictive to bidders. However, if the economics are tilted towards Pemex, bidders will become increasingly wary (read: fewer in number and considerably less aggressive). And what will that really accomplish? Less production and less revenue. If AMLO’s goal is to make Pemex great again, this isn’t the way to do it.

 

Dollars Down the Drain

His presidency just around the corner, AMLO continues to wave the flag for energy self-sufficiency. On paper, the premise makes sense. Mexico has significant oil and gas reserves, and the country is currently in the process of ramping up its production efforts. All the while, Mexico’s six refineries are running at less-than-half utilization and the country currently imports nearly 1 million bbls of refined product every month. That’s a lot of money left on the table, and if Mexico can bring refining in-house, her people will reap the benefit. Sounds like a great plan, right? On paper, it is.

To get started, they’ll just need tens of billions of dollars and a few years to perform the necessary repairs. Oh, and an operations team capable of competing with the Chevrons, Valeros, and Marathons of the world. So yeah, the proposition is fairly straightforward. It’s just not realistic.

Apparently, AMLO doesn’t view these obstacles as a deterrent. To be sure, the country is plowing ahead at the proposed Tabasco refinery site. Can you say doubling down? From an outsider’s perspective, the whole thing makes zero sense. I get nationalism and the appeal of providing for your own people, but at a cost of billions you don’t have?

Meanwhile, the U.S. Gulf Coast is capable of refining more than 8.5 million barrels a day. And all those barrels of gasoline and diesel can be shipped, railed, trucked or piped to Mexico for cents on the gallon.

We will wait and see what becomes of the Mexican refining resurgence. Pesos to invest are limited, and precious. When it comes time to allocate funds, will Pemex plunk down billions to chase pennies? Count me a skeptic.

 

Pesos, Has Anyone Seen Our Pesos?

If you’re a regular reader of this column, you’re well familiar with my claims that Pemex is strapped for cash (when I’m being generous) or broke (when I’m being honest). Though descriptive, neither of those terms fully illustrate the unenviable position that Pemex finds itself in after decades of mismanagement, pilfering and strip mining.

Pemex is the most highly indebted national oil company in the world, with credit obligations exceeding $100 billion dollars. That’s a big number, but it isn’t the only ouch on Pemex’s balance sheet. The Mexican oil giant has racked up a pension liability somewhere in the neighborhood of $65 billion. To say that Pemex has some work to do is a gross understatement.

To his credit, President Pena Nieto saw the writing on the wall. The tidal wave of obligations was surging, and it became clear that Pemex could not escape on its own. The country’s last resort was a modification of the constitution in the form of 2014’s historic energy reforms.

The President-elect has rolled out an aggressive plan to rehab the country’s national oil company. However, Pemex continues to post multi-billion-dollar quarterly losses, adding to the already mountainous existing liabilities. Does AMLO have the ability, willpower and economic buy-in to spend $10 billion annually to turn it around? I doubt it.

Inspired to jump into the Mexican market? Click here to contact our international markets team.

Best,

Chad Smith
Senior Vice President of Terminal Operations