It lost $18 billion in Q4 on declining revenues and production, has $102 billion in debt, and now its world is changing.

By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.

During its heyday in the 1980s, Mexico’s state-owned oil empire, Petroleos de Mexico (Pemex), was the third largest oil producer in the world. That was before the rot of chronic mismanagement, unfettered corruption, and declining oil reserves began to set in. The company, now in its 80th year, excels in only two areas: accumulating massive losses — both in money and stolen oil — and clocking up new record levels of debt.

For the fourth quarter of 2017 the company posted a zinging loss of 352.3 billion pesos ($18 billion), blaming a weaker peso exchange rate, new reporting rules and higher financing costs. The loss compares to a profit of 72.6 billion pesos in the year-ago period. While the group’s sales increased by some 30% over the duration of 2017, largely due to higher oil prices, costs ballooned by 115%.

“Pemex has been roiled by external factors such as the oil crisis of 2015, but it has also been hit by the fact that there have been constant changes in the general management,” says energy analyst Arturo Carranza. The group has had three different management teams in just five years. According to the new boss, Carlos Treviño, installed at the end of 2017, the company’s financial condition is stabilising and the debt situation is now being handled much better.

Whatever Pemex’s new top management might say, the group’s vital signs are still extremely weak. Between 2016 and 2017, its production of crude oil slid 9.5%, from 2.15 million barrels per day to 1.95 million, its lowest level since 1980. Its average daily level of natural gas extraction also fell 12.5% to 5.06 million cubic feet per day.

“Production has been affected by the natural decline of certain fields and a lower quality of crude oil, as well as the company’s limited ability to invest efficiently given thin funding and lack of technological expertise in deepwaters, where future growth is located,” Moody’s recently noted.

But it’s Pemex’s burgeoning debt load that is of greatest concern. In the last five years alone Pemex’s total debt has increased by $38 billion, from €64 billion in December 2012 to $102 billion in December 2017. That’s almost the equivalent of 10% of Mexico’s GDP. And it doesn’t include the company’s pension liabilities, which are estimated to be worth an additional 9% of GDP.

In early February Pemex moved to shore up its finances with a $4 billion bond placement. It also got access to more liquidity via long-term revolving credit facilities for $8 billion. But Moody’s warns of potential clouds on the horizon for the shrinking oil giant:

However, Pemex’s liquidity position is still weak: $8 billion in cash and equivalents, as of September 2017, negatively compares to $4 billion in debt coming due in 2018 and $8 billion in 2019. Management’s goal is to hold at least $4.5 billion in cash at all times.

Moody’s report was released before Pemex reported that it had suffered an $18 billion net income loss in the fourth-quarter of 2017. The big problem Pemex has is that the more debt it adds to its balance sheet, the higher its annual interest expense will grow. In 2017 alone, its total interest expense was $5.9 billion.

To make matters worse, this is all happening as Pemex’s output continues to slump, many of Mexico’s most valuable oil fields are being farmed out to foreign oil majors and competitive pressures are rising sharply in Mexico’s gas station sector, which until recently was the sole preserve of Mexico’s state-owned oil monopoly. In 2016 Pemex’s filling station business generated roughly 730 billion pesos ($36 billion) of revenues. That was before new entrants, including some of the world’s biggest oil majors, were invited into the sector early last year. Since then Pemex’s market share has shrunk by 21%.

There are many reasons why Pemex is in such dire straits, including shockingly bad management, lack of vision, severe budget cuts, shrinking oil reserves, sinking oil prices, lack of investment resulting in poor or obsolete infrastructure, negligence, systemic oil theft from criminal gangs (helped by Pemex employees), and the huge tax burdens the government imposed on it in the years preceding Mexico’s oil reforms, while lavishing foreign companies with massive fiscal incentives to invest in Mexican oil fields. Plus the rampant corruption that infects many levels of the organization.

Given its oversized dependence on public funds, Pemex’s future is more tightly interlinked with Mexico’s government than it has been for a long time. That government could change in July as fears rise that the hotly tipped presidential favorite, populist Andres Lopez Orbrador, could finally win the prize he’s coveted for well over a decade. He has already promised to reverse some aspects of Peña Nieto’s energy reforms and cancel any oil deals that show signs of corruption. That is likely to put his government on collision course with some very important oil majors and global investors.

Pemex’s debt is currently rated Baa3 by Moody’s, just one notch above speculative grade. The group’s outlook is also negative, reflecting the rating agency’s “expectation” that the company’s credit profile could deteriorate further “if managerial and operating discipline is lost along the way.” It’s a veiled warning that should the company or government’s management take a turn for the worse (in the eyes of Moody’s), Pemex’s debt could very quickly lose its investment grade status. And that would make its debt problem even more unmanageable. By Don Quijones.

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