Mexico: Pemex woes deepen amid oil rout

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Record losses and huge debts hit CDS; sovereign contagion free, so far.

By Ben Edwards

Pemex-R-600

April turned out to be the cruellest of months for Mexico’s beleaguered state-owned energy firm Petroleos Mexicanos. Already reeling from a collapse in oil prices and a decade-long decline in crude production, a deadly blast at a petrochemicals plant in southern Mexico that Pemex co-owns with Mexichem claimed the lives of more than two dozen people and injured scores more. That came just over a week after the Mexican government handed Pemex $4.2 billion to help pay overdue bills to suppliers.

The disaster was the latest in a series of fatal incidents involving Pemex; the government’s financial intervention is unlikely to be a one-off either.  "[The intervention] was not enough," says Fabiola Ortiz, analyst at Standard & Poor’s in Mexico City. "It will continue to need support from the government. We need to see what happens with the oil price and the company’s production, but the problems are still there."

Pemex’s financial woes have continued to mount despite the government’s move to open up Mexico’s energy sector for the first time in three quarters of a century – reforms that were supposed to attract foreign investment and help transform the company. Instead the firm has become more entrenched, says John Padilla, managing director at IPD Latin America, an energy consultancy.

"The implosion at Pemex has been much more severe than most people had realised," he says. "Typically with market openings, the expectation is that the state-owned oil company is basically strengthened, but that hasn’t happened."

Record loss

The backdrop is bleak. Pemex posted a record net loss of $30 billion in 2015. The firm remains saddled with debt – it owes about $85 billion – and despite recently agreeing pension reforms, has roughly the same in unfunded pension liabilities. Moody’s cut Pemex’s credit rating to one notch above junk in March; even after April’s mini-bailout, the rating agency says Pemex needs to find a further $13 billion this year to help cover capital spending, interest payments and debt refinancing.

Investors had started to doubt the government’s appetite to stand behind Pemex. Five-year credit default swaps on Pemex debt jumped to 470 basis points at the end of January, more than double where they had been trading a year earlier, according to Markit.

"When you add up all of Pemex’s liabilities, you are looking at in excess of $150 billion between debt and pension liabilities. That’s a big chunk, even for the government," says Padilla. "What the government offered up [in April] was the minimum amount to kick the can down the road, it’s enough of a peace offering to push it off for another day, but it’s not a long-term solution."

For now, Pemex investors seem to be giving the government the benefit of the doubt. CDS levels have been narrowing, trading around 320bp in the last week of April. But the pressure on Mexico remains. At the end of March Moody’s lowered the country’s outlook to negative from stable, stating that any government support to Pemex could undermine Mexico’s fiscal consolidation efforts, already hamstrung by low oil prices and slowing growth.

The country’s debt-to-GDP ratio has continued to creep higher, up to 34.4% in 2015 from 27.9% in 2011, according to Moody’s. If Pemex found itself frozen out of capital markets and relying entirely on state support, that could push the ratio above 40% of GDP by 2018, the rating agency warned.

But sovereign debt investors are not hitting the panic button yet.  "We’re aware of the struggles at Pemex, but we wouldn’t have as large a position in Mexico if we thought the issue was going to be bigger than the market is discounting for," says Jack McIntyre, a fund manager and senior research analyst at Brandywine Global. "Lower oil prices have clearly put pressure on Pemex and Mexico as well, but we think we are being compensated for being there."

Mexico’s benchmark 10-year bond was yielding 5.93% on April 23, down from 6.25% at the end of last year. Meanwhile, an index of dollar-denominated Mexican government bonds yielded 4.34% on 22 April, down from a high of 5.14% in late January, according to Markit.  "The underlying fundamentals in Mexico have been and continue to be positive, it’s just the markets haven’t really cared about that; it’s just getting swept up in the general view on emerging market assets," says McIntyre.

Urgency

For Pemex, however, the problems could become more severe. José Antonio González Anaya, newly installed chief executive, says the company urgently needs to strike joint-ventures with international oil firms to bring in fresh investment and help cut costs. But that won’t be easy.

"Two years ago Pemex was being courted as the most beautiful girl in the room, and everybody was trying to woo them and partner up with them, but fast forward two years and everybody is looking at Pemex differently," says Padilla.

The oil rout has not helped. But Pemex has also been reluctant to cede operating control of its assets regardless of how ownership is split, he says, and that has frustrated potential partners and investors.

"They have to assess the realities of where they stand. Some of it is starting to sink in, but it’s a very tough road ahead," says Padilla.