At the beginning of July, the AMLO government’s biggest bet on energy self-sufficiency — the Dos Bocas refinery in Tabasco — began processing crude oil. But since then, things have not gone according to plan.
Mexico’s economy is in a relatively sweet spot right now, chugging along at an annual growth rate of around 3%. Granted, that’s partly thanks to all the investments flooding in from multinational corporations, including many from China, seeking to “near-shore” part of their operations to North America. The minimum wage has almost doubled in the past four years, unemployment is at a 20-year low of 2.7%, and public debt, at just over 50% of GDP, is relatively low in today’s terms. Inflation, currently at 5%, is also on its way down. In fact, Mexico is one of the only G20 economies to have had real positive interest rates throughout the past three years.
The Weak Link
But the economy has one major weak link: state-owned oil company Petróleos Méxicanos, aka Pemex. With long-term and short-term debt of $110.5 billion (equivalent to almost 10% of Mexico’s GDP) at the end of the second quarter, roughly $80 billion of which is owed to bondholders, Pemex is the world’s most indebted oil company. And it is not exactly in rude financial health, with production stagnating, profits falling 80% year on year in Q2-22, and debt servicing costs climbing.
The company has been plagued by a litany of problems, all of which took root long before President Andrés Manuel Lopéz Orbrador (aka AMLO) took office in late 2018. They include years of severe budget cuts, shrinking oil reserves, chronic mismanagement, lack of vision, lack of investment, negligence, the huge tax burdens imposed on the company in the years preceding Mexico’s energy privatisation reforms (2013-14), rampant pipeline theft (though that appears to have declined since 2020) and simple, plain white-collar corruption.
Put simply, it has been plundered from all directions, most notably from within. Its former CEO Emilio Lozoya went on the run in 2019 after being accused of serious financial irregularities during his tenure. In 2020, he was arrested in Spain and extradited back to Mexico where he is currently in jail awaiting trial on charges including involvement in the Odebrecht scandal, money laundering and influence peddling. Yet during Lozoya’s tenure, when the company was being systematically plundered from within and without, Pemex’s credit ratings remained more or less the same.
To its credit, Mexico’s current AMLO government has slowed or even partially reversed some of Pemex’s worst ailments, first by increasing investment in key areas and second by trying to tackle its widespread culture of corruption and the pipeline theft. Nonetheless, Pemex’s debt load remains dangerously bloated while its labour liabilities have risen from 1.28 trillion pesos ($76 billion) to 1.34 trillion ($80 billion). Even more important, its crude output levels continue to stagnate. With ratings agencies piling on the pressure and the cost of servicing the debt rising, the company is now in need of yet more state assistance. From Reuters:
Mexican state energy company Pemex, whose financial debt ballooned to $110.5 billion by the second quarter, said Friday that it received 64.9 billion pesos ($3.8 billion) from the government to meet its obligations and may tap bond markets this year or next.
It made the disclosure in a filing with the local stock exchange.
Chief Financial Officer Carlos Cortez told investors during an earnings call that despite “significant” government support, Pemex was evaluating whether it would tap bond markets this year or next. He gave no details on how those funds would be used.
The good news for Pemex is that, like any state-owned company, it can, if and when needed, receive assistance from the State. The AMLO government has already put together a $4 billion to help tide the company over. As mentioned before, it has quite a lot of fiscal leeway, given it has significantly lower public debt levels (54% of GDP) than most of its emerging market peers, not to mention most advanced economies. It also has $180 billion in foreign currency reserves and has been able to raise new tax revenues in recent years by simply encouraging inveterate corporate tax avoiders such as Walmart, FEMSA Coca Cola, BBVA and América Móvil, to finally settle their debts.
But the pressure is nonetheless rising from US ratings agencies. On July 14, Fitch downgraded Pemex’s Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) to ‘B+’ from ‘BB-‘ and put the company on rating watch negative, citing the company’s weak operating performance, particularly (and this is key) in the ESG (environment, sustainability and governance) criteria. Some key points from the report:
- “Pemex faces international debt bond maturities of USD4.6 billion in 2023 and USD10.9 billion in 2024. The refinancing of this debt will expose the company to higher interest expense that would further stress its cash flow.”
- “Pemex is in financial distress, and its ESG track record further impairs its ability to raise capital. The company reported USD107 billion of debt as of 1Q23, USD73 billion in PPE, and negative equity book value of USD95 billion.”
- “As of 1Q23, Pemex reported USD25 billion of short-term debt, of which USD4.6 billion are in international bonds due in 2023 and USD10.9 billion in 2024. The company is highly reliant on international capital markets to refinance its existing debt, as 85% of its total debt is in hard currency. In the event Pemex continues rolling its financial maturities into short-term debt, Fitch estimates the company will conclude 2024 with nearly 35% of its total debt being short-term.”
- “Over the rated horizon, Fitch estimates that Pemex will be an increasing liability for the government. Contrary to previous years, where the government take exceeded Pemex’s cash support needs, Fitch estimates under our rating case that the government will have to spend roughly USD 20 billion more than it receives from the company in 2026 and 2027, to keep Pemex afloat.”
AMLO responded to Fitch’s downgrades by unleashing one of his trademark tirades against neoliberalism.
“It is like at this point taking into account the opinion of the IMF, which is totally discredited,” he said, adding that the recent crisis in Argentina was exacerbated by the IMF for political and ideological reasons. “Macri was president and they wanted him to be reelected, and for the left not to win, so they injected a lot of money into Argentina’s economy through credits authorised by the IMF.”
A History of Downgrades
Pemex’s bonds were first downgraded to junk in June 2019, by Fitch. This forced some institutional investors to shed the company’s bonds, which in turn raised Pemex’s costs of borrowing. Ten months later, at the height of the COVID-19 virus crisis, Moody’s did the same, citing as reasons both the economic chaos caused by the economic crisis as well as AMLO’s goals of achieving energy independence for Mexico.
When Moody’s joined Fitch in downgrading Pemex to junk – giving it two downgrades from investment-grade to junk — Pemex become the largest “fallen angel” in history, with a debt load twice as large as the previous title holder, Petrobras.
As I wrote for WOLF STREET in June 2019, Fitch and Moody’s downgrades were “a double shot across the bow meant to spur Mexico’s populist President Andrés Manuel Lopez Obrador (AMLO) to reduce Pemex’s fiscal burden, pledge significantly more public funds to clean up the oil giant’s balance sheet, and stage a retreat from his nationalist energy strategy, which is popular among voters and loathed by investors, particularly overseas ones.”
AMLO’s response then was to hit back at the rating agencies, accusing them of a lack of professionalism, of looking the other way as the last government plundered Pemex, and of using outdated methodologies that do not include variables such as corruption.
In three years there was no investment in exploration, there was no investment in drilling wells in Pemex, and they rated Pemex very highly. Now that there is investment, they downgrade Pemex. I assure you that corruption is no longer tolerated. So, we have these discrepancies.
Since then, AMLO’s government has poured billions of dollars of public money into Pemex’s balance sheets in an attempt to steady the ship and improve the company’s performance, with mixed results. In 2020 Pemex finally put an end to an unbroken 15-year rough patch of sliding production, only for production to slide once again last year. AMLO’s government has also waged a multi-pronged offensive against the rampant oil theft that was draining the state-owned oil company of an estimated $3 billion a year, again with mixed results: for a couple of years the amount of oil stolen fell sharply but is now rising once again.
AMLO’s Quest for Energy Self Sufficiency
Most importantly, AMLO has refused to stage a retreat from his nationalist energy policy, despite public criticism from the US government, the IMF and US ratings agencies. During his four and a half years in power, the AMLO government has rolled back many of the privatisation and market liberalisation policies of previous administrations. It has tried to ensure that the national grid obtains at least 54% of its energy from public sources and then, as needed, from private ones. And it has invested billions of dollars in the construction of the Dos Bocas refinery, in AMLO’s home state of Tabasco, as well as refurbishing old refineries.
In August 2021, AMLO announced that Mexico will stop selling crude oil abroad and will only extract the oil that it needs to produce the gasoline the country requires. As I reported at the time, it would be great news for Mexico as a whole, especially given how important fuel prices are in driving broader inflation, but bad news for its northern neighbour:
Over the past three decades Mexico has become an increasingly important consumer of US petroleum products, particularly finished gasoline.
In 1993, on the eve of NAFTA, Mexico imported an average of 58,000 barrels of gasoline per day from the US, according to the US Energy Information Administration. By 2004 that figure had almost doubled, to 104,000. Ten years later, Mexico became a net importer of petroleum products from the U.S. for the first time in at least 40 years, importing 196,000 barrels of gasoline per day. Fast forward to today and the figure has more than doubled once again, to 462,000 — an eight-fold increase in 28 years.
Before AMLO’s presidency, Mexico had not built a new oil refinery in 40 years. After decades of under-investment many of those that were still standing were in a dilapidated state. By 2017, a year before AMLO became president, they were operating at 51% of capacity, leaving Mexico little choice but to ship its oil to the US and buy it back as finished gasoline, turning it into the world’s second-largest gasoline importer. Which suited the US and its huge refining companies just fine.
But AMLO is determined to reverse that trend. To that end, in early 2021 Pemex bought out its partner Royal Dutch Shell’s controlling interest in the Deer Park refinery in Houston, Texas, making Pemex the sole owner of the refinery. The goal is to reduce Mexico’s imports of gasoline to the marginal level of around 34,000 b/d in 2024, from 900,000 b/d in 2019. According to Pemex CEO Octavio Romero Oropeza, the gasoline imports will fall to around 232,000 b/d this year. The key to the plan is the Dos Bocas refinery in Tabasco, which started processing crude oil in early July, just four years after construction began on the project.
Since then, strange things have happened. Pemex has continued to suffer a string of oil rig fires and accidents that began in February, including a huge explosion on a rig in mid-July that may have led to the loss of roughly two million barrels, according to estimates from Reuters. These accidents contributed to Fitch’s downgrade of Pemex’s credit score and downgrade. Also, just three days ago (July 28), Daniel Flores Nava, a contractor for the Dos Bocas refinery and other Pemex refineries as well as a close friend of presidential candidate and AMLO confidante Adán Agosto, died in a small plane crash over the gulf of Mexico.
The opening of Dos Bocas was supposed to mark the beginning of a new era for Mexico’s energy industry. Instead, the public debate has been dominated by accusations of industrial negligence, environmental damage and mismanagement while Pemex’s debt servicing costs have surged.