Tectonic shifts and clouds of uncertainty after Sunday’s election.

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

Since the election on July 1 of veteran leftist politician Andres Manuel Lopez Obrador (AMLO for short), a dark cloud of uncertainty has gathered over the future of Mexico’s oil industry, which was already in dire enough straits. After decades of chronic mismanagement, unfettered corruption, and declining oil reserves, Mexico’s state-owned oil empire, Petroleos de Mexico (Pemex), once the world’s third largest oil producer, excels in only two areas: accumulating massive losses — both in money and stolen oil — and clocking up new record levels of debt.

Now, there are fears among investors, both domestic and foreign, that AMLO could reverse his predecessor Enrique Peña Nieto’s energy reforms, which reopened the oil and gas sector to foreign investors, ending Pemex’s monopoly after almost eight decades.

On the campaign trail, AMLO repeatedly pledged to suspend new oil auctions and review contracts issued to private energy firms for signs of corruption. Given those contracts were drawn up by the Mexican government and Pemex, two institutions that are riddled with corruption, as well as some of the world’s biggest oil majors, those signs shouldn’t be hard to find.

Since then, the president-elect’s senior finance official, Carlos Urzua, has tried to mollify fears by clarifying that the AMLO government was not planning on pursuing major legislative overhauls of the oil sector. But not everyone’s convinced.

On Monday, Moody’s warned that AMLO’s election would lead to short-term market volatility and represented risks for the oil sector. Fitch Ratings echoed those claims, cautioning that the election would bring prolonged uncertainty. Cancelling multi-billion dollar oil and gas contracts is also likely to put AMLO’s government on collision course with some very important oil majors and global investors. According to the Mexican daily El Excelsior, the contracts signed to date alone represent a projected investment of around $200 billion dollars.

With AMLO scheduled to take the reins of government in December, Pemex is frantically accelerating its farm-out program. It hopes to choose new partners in at least seven onshore oil fields later this year, as well as make an announcement in late July on three refinery joint-venture agreements.

But attracting investors in the current climate of uncertainty may be more difficult than it was. Lopez Obrador propounds a more nationalistic energy strategy than the current government, raising fears of messy, costly expropriations. AMLO’s party, Morena, will have control not just of Mexico’s executive branch, but also the nation’s Congress and Senate. While there are certain regulatory safeguards in place to minimize the risk of excessive government interference, they could be changed with a simple majority in Congress.

AMLO has also said he may temporarily freeze gasoline prices, which have soared in the last year and a half following the deeply unpopular withdrawal of government subsidies in the famed gasolinazo of January 2017. He has also proposed building two new refineries at a cost of billions of dollars each.

Paying for such measures will not be easy, however, especially given Pemex’s precarious financial condition. Over the past several years, the shrinking oil giant has failed to stem long-term production declines, reverse refinery losses and has continually piled on fresh debt. In the last five years alone Pemex’s total debt has increased by $42 billion, from €64 billion in December 2012 to $106 billion in March 2018. That’s the equivalent of over 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.

All the while, the company’s output continues to flag. Between 2016 and 2017, its production of crude oil slid 9.5%, from 2.15 million barrels per day (bpd) to 1.95 million bpd, its lowest level since 1980. By March it has slipped further, to 1.87 million bpd. Its average daily level of natural gas extraction also fell 12.5% to 5.06 billion cubic feet per day.

Trying to raise investment as Pemex’s losses and debt pile up while its output continues to fall will be no mean feat, particularly if Pemex’s deteriorating health begins to take a toll on the cost of issuing new debt for Mexico’s government. 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.

As Fitch notes, Pemex’s credit rating is the same level as Mexico’s sovereign debt rating, since they are both highly dependent on one another, although Pemex’s contribution to state coffers has shrunk by around half in the last decade. As such, the Mexican government has a very strong incentive to continue supporting Pemex, given the severe consequences the company’s deteriorating health could have on the country’s economy.

The stark reality, when it comes to Mexico’s struggling oil industry, is that AMLO’s hands are already more-or-less tied before he even takes power. If he adopts too radical an approach, he risks scaring off footloose foreign money and the cost of debt, both for Pemex and Mexico’s government, could surge.

Pemex’s predicament is a result of a dizzying array of factors that are years, if not decades, in the making. They include bad management, severe budget cuts, shrinking oil reserves, 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 the firm in the years preceding Mexico’s oil reforms, while lavishing foreign companies with massive fiscal incentives to invest in Mexican oil fields. That’s not to mention the rampant corruption that infects many levels of the organization.

Just trying to reverse any one of these deeply debilitating trends will be a gargantuan task, in particular with regard to the last one. AMLO ran on a strong anti-corruption ticket, and if his government were to begin addressing the systemic corruption and culture of impunity that have bled Pemex dry while filling the pockets of crooked contractors, executives, unions, and politicians, then perhaps Pemex, and by extension Mexico as a whole, may have a somewhat brighter future. But it’s a big “IF”. By Don Quijones.

Just as the gasoline market is opened to competition, Mexico becomes one of the worst places in the world for fuel theft. Read…  Petro-Plunder Rages in Mexico, Costs Surge 

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