ICIS View: Mexico economic outlook complex if low oil prices persist

Author: Claudia Espinosa

2020/03/11

Persistently low oil prices would put country, credit rating at risk

Crude production, cash flow critical for Pemex in 2020

National public finance situation nuanced - think tank

Credibility in coming energy infrastructure plan is key

Market participants are monitoring the effect that a potential prolonged low oil price environment could have on Mexico’s country and credit risk after crude prices fell to record lows this week, something that could hurt state-run producer Pemex’s cash flow and contributions to the federal budget during a critical year for the new administration.

Mexico’s Treasury Secretary Arturo Herrera publicly stated on 10 March there would be no direct budget impact because the country’s oil income is “completely” hedged, a statement that could be misleading to some observers, according to Ana Lilia Moreno, an economist and researcher at Mexican think thank Mexico Evalua. The Treasury did not immediately respond for comment.

Moreno, whose team of Mexico’s federal budget, said the hedge does cover Mexico’s oil income but not Pemex’s, meaning its oil hedge, which is not publicly available, does not help the company’s prospects for improving cash flow if low oil prices persist. This is an indicator that credit ratings agencies, which in 2019 downgraded and published negative outlooks for the country, are expected to monitor as they evaluate Pemex and the country’s creditworthiness. Credit ratings agency Fitch did not immediately respond for comment.

Ariane Ortiz-Bollin, assistant vice president of ratings agency Moody’s sovereign risk group, said the agency is currently evaluating the impact of the oil supply shock on Pemex’s credit profile.

“In the case of sovereign [credit], the negative outlook for the A3 rating had already incorporated the risk that Pemex could require substantial, ongoing support from the government, given the negative cash flow the company has reported and its capital investment needs. The drop in oil prices and the risk that these could stay low amplify this risk,” she said on 11 March.

Ortiz-Bollin also said the hedges Herrera referred to would “mitigate the impact of a lower price for Mexico’s Maya crude on federal revenues, but only for this year. On the other hand, we revised our growth estimate for Mexico to 0.9% this year given the direct and indirect impact of the Covid-19 shock, which we expect will affect economic activity during the first half of 2020, with additional downside risks.”

Pemex’s crude production levels will, perhaps more than ever, continue to matter along with energy policy planning since the producer’s operating costs are difficult to streamline, according to Moreno, in part because of its rigid union contracts. Pemex union members are also a part of president Andres Manuel Lopez Obrador (AMLO)’s voting base, whom his divided ruling MORENA party will be counting on for 2021 elections.

PUBLIC FINANCES

AMLO’s administration has thus far been considered fiscally disciplined but research from another Mexico Evalua initiative evaluating the use of public funds actually met their targets for reducing spending last year and Mexican Pesos (Ps) 300bn ($14.3bn) of revenues anticipated in the 2019 budget never materialised because of reduced revenues from the sale of crude and the value-added (IVA) and income (ISR) taxes.

Their analysis of 2019 Treasury data shows the administration used nearly 50% of the country’s budget stabilisation fund, known as FEIP in Spanish, to cover the shortfall, transferring Ps122bn to Pemex. Federal revenues would have to increase by 5% or Ps266bn on the year in 2020 to meet targets without dipping into the FEIP, the think tank said in a 4 March press release.

Mexico could thus be in an even more precarious situation this year in light of these constraints, a potentially prolonged low oil price environment and the country’s experience of a mild recession in 2019.

ENERGY PLANNING

Mexico’s private sector and foreign investor community have attempted to have dialogue with AMLO’s administration since its transition, with frustrating results and controversial energy policy shifts that have solidified the perception of the administration as ideologically rigid.

The administration is currently debating an energy infrastructure plan that would include the private sector, and its release has been postponed multiple times, sources say, because of a clash between pragmatists and resource nationalists such as energy minister Rocio Nahle and the head of state-run utility Manuel Bartlett.

“The thing is that [Nahle] and Bartlett keep pushing the idea of zero private sector participation. But I hope after the Pemex results maybe things could change a bit,” said one Mexico-based energy consultant. Pemex again reported losses in its most recent earnings.

Moreno said she sees AMLO, who has a highly-centralised style of policy planning, as being responsive not to data or technical expertise but to the state of public finances and Mexico’s exchange rate value because of his formative experiences during the country’s worst economic crises. The economist said she thinks lower revenues and a further contraction in GDP could also prompt AMLO to reconsider his ideologically-driven decisions.

LAST CHANCE

The forthcoming energy infrastructure plan may represent the administration’s final chance to display an ability to recalibrate and integrate the lessons of mature energy markets as it grapples with how to deal with a completely unexpected drop in oil prices.

Victor Ramirez, a spokesman for Platforma Mexico Clima y Energia said a lot depends on how long the global crisis lasts, on AMLO’s economic team and to what degree he listens to them. Ramirez and other market sources polled said they think Treasury Secretary Herrera, who is currently a doctoral candidate at New York University, is a very competent economist.

This year may present his most difficult project yet. Claudia Espinosa