The Long and Short
Challenges at Pemex
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Mexico’s state-owned oil company, Pemex, faces significant challenges as it grapples with declining production and mounting debt under the administration of President Andrés Manuel López Obrador (AMLO). Despite spending over $30 billion to combat historical production declines, Pemex has only managed to stabilize rather than increase production. Crude oil production as of May 2023 stood at 1.61 million barrels per day (mbpd), falling short of the 2019 average of 1.67 mbpd after 0.5 mbpd of new production failed to fully offset the depletion of old wells. And while increased drilling in core fields has contributed to new production, it has also accelerated depletion in older fields, posing a long-term problem.
The company’s future prospects for production growth are uncertain. Existing joint ventures come with limited scale and limited immediate production and cash flow potential, while over 100 farm-out contracts have been shelved since AMLO assumed power. This creates a void for production and cash flow growth in the coming years. Compounding the situation is the fact that nearly $27 billion of Pemex’s public debt is scheduled to mature by the end of 2026, presenting a daunting challenge.
Financial markets have responded to Pemex’s increasing risk, with spreads to the sovereign breaching 600 bp in recent sessions. However, the belief that these spreads offer value is losing momentum, and the market is left with a binary scenario of government assistance or further deterioration. While a resolution seems inevitable, the upcoming USD blackout from July 20 to August 27 suggests that any government support measures may be delayed until after this period.
Despite the current yield levels exceeding 12% required to access the bond markets, investors are still on the lookout for new opportunities. However, given the near-term amortization pressure and approximately $2.5 billion in public bonds scheduled to mature in the remainder of 2023, bond market activity is unlikely in the near term. The situation worsens in 2024, with an additional $10 billion in principal due, making capital raising likely in concert with government assistance potentially through a tender process.
Though there is comparatively less demand for non-dollar issuance, an initial ESG strategy by the company might assuage some hesitancy on the part of European investors, particularly considering Pemex has paid down nearly EUR2 billion in outstanding issuance over the last 12 months. This potential issuance thesis is a bit of a stretch, however, given my interaction with clients in Europe. There is potential for secured issuance collateralized by oil or future deliveries or other more complex structured debt solutions. And while there is risk of structural subordination for existing bond holders, the positives in liquidity generation and assumed reduction in bonds outstanding would combine to more than offset priming considerations. Moreover, the potential quantum of such issuance looks unlikely to be large enough to create a material subordination risk.
Pemex’s operational performance this year has been unremarkable, with marginal improvements in sequential EBITDA generation. Although reported debt is slightly lower, it has not shown a substantial improvement as expected due to the appreciation of the Mexican peso. Credit lines remain fully drawn, and the company’s cash reserves stand at minimal operating levels of around $3 billion.
While the spread differential suggests that Pemex’s credit is undervalued, investors are increasingly frustrated with the company’s Band-Aid approach to balance sheet management and the lack of comprehensive government support. ESG concerns are also chipping away at investor interest. It is becoming evident that a larger government-sponsored initiative is needed to address the company’s balance sheet issues and positively influence market sentiment. Possibilities include a UMS-sponsored issuance program, a Petro bond program, or a broad tender initiative, or a combination of these options. The current “status quo” appears exhausted, and without significant catalysts, Pemex’s bonds may not offer attractive value in the near term.
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