Uncertain Future for Mexico’s State Oil Company

The release of slowing GDP growth data for the first quarter of 2019 has added to the sense of uncertainty surrounding Mexico’s economy, particularly in the energy sector. Andrés Manuel López Obrador (AMLO) assumed office as the country’s president on December 1, 2018.  Within days of taking office, his administration began taking actions to limit foreign influence in the energy sector and strengthen domestic actors.  Reforms in 2013 had allowed foreign participation in oil auctions for the first time in eight decades. Yet in early December 2018, AMLO suspended new auctions for the next three years. Paradoxically, this may in fact limit the long-term prospects of the state oil company, Petróleos Mexicanos (Pemex). More recently, his administration has adopted a plan that was partially released on July 16, 2019, which aims to improve the outlook for the state oil company. Pemex currently faces a multitude of challenges, such as significant levels of debt, high tax rates, and falling output. These, in turn, have led to the potential for other related problems, such as the reduction of Pemex’s debt rating to “junk” by a second agency. Many analysts fear that the July 16 plan will not be enough to improve the long-term prospects of the company and or to allay the fears of investors and rating agencies.

Pemex faces an uphill battle towards further development and profitability. The company holds a debt burden of $106.5 billion, higher than that of any other oil company in the world. The debt picture has not improved recently, with Pemex facing a loss of $6.7 billion in 2018. The debt held by Pemex surpasses 10% of Mexico’s national GDP. Falling production will not improve the prospects for debt repayment. Oil production has fallen for over a decade, with a sharp 35% decline in the past five years through January 2019. One reason for the falling production is falling investment, particularly in exploration and production, and to a lesser extent in refining. Investment in exploration and production decreased by roughly $16 billion from 2014 to 2018. While the company may eventually require investment to increase refining capability, the need is not exactly pressing at the moment, as Pemex refineries ran at 1/3 capacity in April 2019. Lastly, Pemex historically faces prohibitively stratospheric tax rates that inhibit development. The company currently faces a tax rate of 65%, and these funds provide for roughly 20% of the national government budget.

Many of AMLO’s actions since assuming office have not impressed outside analysts, and the release of the July 16 plan contributed to the growing skepticism. Some foreign oil companies, such as the Italian firm Eni, had already begun work on Mexican oil fields after the 2013 reform, long before AMLO assumed office in 2018. AMLO has since ended new foreign investment in the sector. This will limit the ability of Pemex to expand into some areas in the future, as only foreign companies hold the expertise to carry out deepwater drilling. The July 16 plan calls for various changes for Pemex. These changes include tax rate deductions of 11% by 2021, $104.6 billion in investment over the next six years (largely drawn from the company’s own revenue), and a shift in focus to onshore and shallow water fields.  Planned investments include $8 billion for the Dos Bocas refinery. Outside analysts fear that these actions may not be appropriate responses to the problems Pemex faces and that the magnitude of the response is also insufficient. Some forecast that a second rating agency will follow Fitch in downgrading the debt of Pemex below investment grade, which occurred on June 6, 2019.

Other choices and avenues could improve the prospects for Pemex. Three particular changes could potentially raise the long-term prospects of the firm and decrease the risk of ratings reduction. First, the company should allow foreign investment, and attract expert foreign firms to help develop comparatively high-return deep-water drilling sites. This would shift away from the current focus on onshore and shallow water productions. Second, the company should reduce the current emphasis on developing the refining sector, and instead shift towards exploration and production. Since current refineries are running at 1/3 capacity, the current construction at the Dos Bocas refinery seems redundant. Lastly, the government should reduce the tax burden on Pemex further, which would free up more capital for investment and reduce the need for more debt. If such changes do not occur with alacrity, the company may face low production growth, high debt levels, and a second debt rating reduction in the near future.

Relevant actors in the industry and in regulatory bodies should pressure the current administration to make the aforementioned changes. If Pemex does not make these changes, the company will continue to face production and debt-related challenges in the future.

About the Author

Dwight Lindquist

Dwight Lindquist is a Risk Specialist at Global Risk Intelligence. He is currently an MA candidate in International Studies at the Johns Hopkins University in Nanjing, China. Dwight is fluent in English and Mandarin, previously earning a Certificate from the East China Normal University in Shanghai. He is based between China and the US.

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