Fixed Income Analysis /

Pemex: The AMLO effect

    Rafael Elias
    Rafael Elias

    Director, Latin America Credit

    Tellimer Research
    19 November 2018
    Published byTellimer Research

    Petróleos Mexicanos (PEMEX) has traditionally been a strong Mexican quasi-sovereign, widely covered by the ‘Street’, with investment-grade ratings across the board (Baa3/BBB+/BBB+). But we have been getting many questions about the recent drop in prices of Pemex bonds and the widening of spreads relative to the sovereign. 

    Below we list the reasons why we believe this is happening and, most importantly, explain why we believe that we have not yet seen the end of this negative rout. The main reasons are:

    • External reasons such as the recent drop in oil prices, which needs no further explanation.
    • Internal reasons such as the appointment of Octavio Romero Oropeza, an agronomist engineer, as the future head of the company. Oropeza has no previous experience in the energy sector and is seen by many as a loyalist appointment by President-elect López Obrador (AMLO).
    • The fact that AMLO and his economic team have said that spending at Pemex will be mostly be allocated to the refining segment of the company with the refurbishing of the existing refineries and the construction of a new refinery in AMLO’s native state of Tabasco. This is a low margin segment, compared to the margins that Pemex can achieve when prioritising investment in exploration and production.
    • AMLO’s statements that Pemex will stop exporting crude and that all production will be used domestically to feed the refineries, effectively causing a negative effect in terms of generation of foreign currency revenues and a mismatch between these revenues and the company’s debt, which is mostly denominated in hard currencies.
    • AMLO’s statement that his government will “suspend” any future auctions of new fields in the deep waters of the Gulf of Mexico (the main component of the Energy Reform that was aimed at promoting private investment in these fields in order to optimise its financial allocations and gain technological knowledge and increase production, which has dropped by more than 30% over the past 10 years). This, effectively puts a halt to the Energy Reform, as AMLO has said that no further auctions will take place until at least the first oil of previous awarded contacts is produced (a process that could take 7 to 10 years).
    • The recent wave of early retirements by government officials across the public sector in Mexico, driven by AMLO’s slashing of wages and the fact that those who retire now will have their pensions based on their current salaries rather than on the reduced wages that they would make if they stayed in their posts beyond 1 December, when this law is expected to be enacted.
    • Fears of a brain drain with a potential decrease in the capabilities, expertise, experience and overall knowledge of new Pemex workers hired under the new, much lower pay base resulting from the above point.
    •  Uncertainty resulting from the possibility of potential negative ratings actions by the main agencies, all of whom are attentive to the directives that the new administration will implement once in office.
    • Uncertainty related to the direction that Pemex will take regarding the funding of future projects (particularly given the suspension of future auctions to explore and produce in the deep waters of the Gulf of Mexico).

    Considering the above, we believe that spreads will continue to widen, and Pemex’s bond prices will continue to gradually but steadily drop until and unless the new management realises that the strategy that has been defined for the company is erroneous and could lead to negative consequences in terms of production, foreign currency generation, margins, profitability, and certainty for investors to continue investing in Pemex. This is particularly so when other regional alternatives (such as Petrobras and Ecopetrol in Brazil and Colombia, respectively) appear to have much better outlooks and improving fundamentals.