With AMLO continuing to double down on his vision of energy sovereignty six months into office, supply security throughout the entire energy value chain is rapidly deteriorating. Many of the problems plaguing Mexico’s energy sector are years in the making. AMLO is now exacerbating some, and his nationalistic policies will impose an extremely high cost. Here are some of the signposts that need to be fully considered and placed in context:
- PEMEX Production Decline Will Continue: PEMEX has already lowered its oil production targets for 2019 twice. Further reductions, whether announced or not, are a given for 2019-2024. Based on our detailed projections, PEMEX´s short-term “solutions” are compromising the value of new exploratory efforts.
- Oil Prices Can No Longer Save Mexico: Oil prices will unlikely come to the rescue of PEMEX and the government in the way they have over the last 15 years as production continues to slide. With production at less than half of its peak in 2004, any hope for a return to high oil prices won’t be enough to offset structural losses that will persist in the short- to medium-term. The impact on the Mexican government’s revenues and undiversified local economies, particularly in the south, will be substantial if the current strategy stays its course. Our graph on the following page provides food for thought.
- PEMEX and CFE 1Q 2019 Financials Speak to Bigger Problems: The financial losses posted by PEMEX and the Federal Electricity Commission (CFE) in the first quarter are alarming and should be raising flags. Deeper seeded problems, like subsidies and continued fuel theft, are plaguing these monopolies.
- Blackouts and Curtailments Are Important Warning Signs: Electricity blackouts and natural gas curtailments that have emerged over the last few months will have further economic impact in the months to come and speak to structural problems.
- Austerity Measures Are Not Working: Austerity measures implemented across the board are having the opposite impact intended as a major exodus of personnel is taking place at PEMEX, as well as throughout government-related energy sector entities.
- Money Won’t Fix PEMEX: Despite a continued debate over how much money PEMEX ultimately requires to reverse its multi-year production and reserves decline, no amount of money alone will resolve what ails the company in our view. Operational and technical failings in recent years have only been further eroded by AMLO’s austerity measures.
- Market Confidence Has Been Rattled: The cost of capital in Mexico is rising as market uncertainty foments, with AMLO doing little to convince investors that he will fundamentally fix PEMEX (the CFE too). The government’s insistence that PEMEX build the Dos Bocas refinery instead of hiring an EPC contractor and continued inadequate E&P funding are the principal issues.
- New Sector Investment Has Stalled: New energy sector investment (not to be confused with investment required under already awarded blocks and commitments) is broadly on hold.
- Industrial Production and Economic Output in Jeopardy: Industrial production contracted by 2.6% in March compared to one year ago, and by 1.3% compared to February. With industrial production representing 30% of GDP, the threat of looming credit downgrades becomes all the more acute.
- Peso Decline May Be the Trigger Point: The impact of the recent fall in the Mexican Peso caused by the threat of increased U.S. tariffs will start to further debilitate an economy already teetering from the problems outlined above. Even if an agreement with the U.S. on tariffs is reached, the damage to market confidence and threat of increased volatility may already be in motion.
All of this leads us to focus on a single dynamic that has not been tested in modern Mexico. If increased PEMEX production and the directly related government revenues the AMLO administration is anticipating cannot be achieved, what will AMLO’s alternatives be if he sticks to his adamant promises of not raising taxes (the historic fallback mechanism over several administrations), maintaining a balanced budget, continuing to provide subsidies, and funding various social programs? A review of the graph below begs the question of how long the current energy sector strategy can be sustained.