Mexico — Hydrocarbon Windfall

  • Mexico’s trade position with respect to oil has deteriorated significantly as a function of declining prices, falling production and a disadvantageous mix of high-value added refined imports versus low-value added exports.
  • Mexico’s swapping of unrefined exports for higher value refined product imports has resulted in Pemex becoming a NET IMPORTER since June 2015.
  • At its peak, Pemex generated over US$3 billion in monthly income from exports (net of imports). Recent data shows a net deficit position of -US$164 million on a 3-month moving average basis.
  • Absent a correction in oil prices, an increase in domestic production, or boosting refining capacity, Pemex’s ability to generate net hard currency income appears to be a thing of the past.
  • We believe that ultimately increases in production, led by private sector investment, will result in a return to surplus, though this will take many years and many billions in new investment.
Source: Pemex database as of 7/31/16

While Mexico’s economy has historically been heavily tied to oil, over the last 30 years growth in the manufacturing and tourism industries (among others) has allowed the economy to become more diversified. Today, Mexico is far less tied to oil than countries such as Venezuela and Russia, who have failed to diversify their economies. Nonetheless, Mexico’s trade position with respect to oil has deteriorated significantly, not merely as a function of declining prices[1], but also production[2] and the mix of imports versus exports (see Graph). Mexico generates hard currency by exporting unrefined crude, and exports of crude have been relatively in line with last year (up 3.0% YoY). Unfortunately, a significant amount of these export proceeds are spent to purchase refined products, unleaded and diesel, in the international markets.

Mexico Revenues vs. Expenses: An Unfortunate Tip of the Balance

The need to acquire refined products from abroad highlights a lack of domestic refining capacity, which is related to low capacity utilization as a result of lack of maintenance as well as the prohibitively expensive nature of building refineries in the emerging world –largely a function of graft. Corruption creates a barrier to entry and is unfortunately a reality of developing large-scale investment projects in the emerging world and hinders Mexico’s development of additional refining capacity.

In Mexico’s case, swapping of unrefined for refined product has resulted in a decline of the windfall to Pemex from the export of oil. At its peak, Mexico’s net balance from hydrocarbons, which we estimate based on netting crude exports with imports of distillate provided by Pemex, generated over US$3.0 billion in monthly net receivables as recently as April 2008. In recent months, this figure has entered into negative territory and posted a -$164 billion decline on a 3-month moving average basis through July 2016.

Increased Production is in the Horizon, but Still Some Time Away

All of this is occurring in an environment where Mexico is expecting to replace internal Pemex production with shared and private sector production. While we still believe that the oil play in Mexico offers substantial value, the reality is that the first oil produced from the sale of private sector exploration rights is years away. Some estimates suggest that 2 years may be possible, but most experts seem to think that any significant, commercially viable, new production is 4–5 years away. One might hope that Pemex will be able to bring some of the fields that it reserved into production more quickly with joint ventures leveraging minority participants’ better technology and expertise, but the reality appears to be that the prospects for Pemex increasing its declining production are some time away.

Anemic production combined with declining terms of trade have been exacerbated by Pemex’s high indebtedness, which has prompted austerity measures, including significant layoffs, in an effort to reduce costs. The April explosion at Pemex’s petrochemical plant, Petroquimica Mexicana de Vinilo, only added to the company’s woes.

Pemex Weakness add to Stress Created by Anemic U.S. Growth

Absent a correction in oil prices, an increase in domestic production, or refining capacity, Pemex’s ability to generate net hard currency income appears to be a thing of the past. This reality places the Mexican budget and balance of payments in a more precarious situation than it has seen in recent years. Unlike the last several years, the wind is not at Mexico’s back and the hard currency windfall from hydrocarbon exports and the benefits of hedging at higher prices cannot be relied upon. Further declines in production, or failure to develop refining capacity, impair both Pemex and Mexico’s long-term financial security.

The declining economic contribution from Pemex has weakened the Mexican growth story in 2016 and is contributing to downward revisions of 2017 growth. It is unfortunate that this is taking place in the context of the protracted low-growth phase in the US and should contribute to a reduction in Mexico’s growth expectations at precisely the time that Mexico should be seeing stronger overall growth. In fact, leveraging the successful diversification of its economy, and the tailwind of game-changing reforms in the oil and energy sectors (among others), Mexico should be in an economic sweet spot. While Mexico’s private sector appears to be seeing strong growth trends, the public sector (of which Pemex is a major contributor) is weighing heavily on the overall growth story.

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