The Long and Short
Pemex faces challenges but gets support
Declan Hanlon | September 15, 2023
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, finds itself with improving prospects of needed financial support from the government. Over the summer, there have been signs that the Mexican government’s 2024 budget may allocate explicit funds to address Pemex’s substantial public debt, which is set to exceed $11 billion in principal payments due next year.
This potential financial aid appears to perpetuate a “Band Aid” support strategy that has characterized President Andres Manuel Lopez Obrador’s (AMLO) administration. Although some investors have criticized the lack of a systemic solution to Pemex’s balance sheet problems, the cumulative direct and indirect support provided during AMLO’s tenure has surpassed $40 billion. With AMLO in his final year in office, the key question now is whether the incoming administration will maintain a similar interest in directing capital towards the beleaguered company.
In the short term, Pemex’s 10-year spreads have shown some improvement, narrowing from approximately 12% to around 550 bp above the sovereign benchmark. This improvement reflects growing expectations of support. However, despite the end of the blackout period for USD issuance in August, current yields do not suggest a high likelihood of new issuance. It looks like a yield threshold close to the 10% seen in Pemex’s most recent bond issue in February would be required to attract investor interest. Though theoretically, Pemex could benefit from duration, without incremental cost, the $68 dollar price 11.6% long bond suggests any investor appetite for par paper in that part of the curve to be essentially nil.
Pemex’s financial picture was temporarily brightened in July when it received approximately $3.8 billion in state support, sufficient to meet amortization requirements for the rest of the year. However, some of this capital injection is likely to be allocated to operations or capital expenditures, potentially necessitating additional support by year-end. Contrary to reports, there are doubts about whether the equity injection came with requirements to cut capex or opex. Further, though Hacienda (Mexican Treasury) and Pemex decided on the most recent capital injection, another alternative was a secured oil receivables facility that could have generated $2 billion in cash this year with a up to $4 billion from 2024 through 2025. But the required high single digit interest rate apparently was unpalatable for the firm. This structure—oil contracts delivered to an SPV that subsequently issues secured financing—remains an option, as market conditions evolve.
Discussions apparently are underway to refinance the USD components of existing credit lines, including a $1.5 billion PMI line due in December this year and the remaining $8.0 billion jumbo line maturing in June 2024. While refinancing of the PMI line is expected, the new jumbo line may be smaller, possibly by as much as $2.50 billion, in response to reduced risk exposure requirements and ESG stipulations from the associated bank group. If market conditions do not align, it’s anticipated that governmental support will bridge the gap.
Looking ahead, Pemex faces a significant $11 billion or greater amortization schedule in 2024, adding to the category of expected Hacienda support. With market levels unlikely to dip below the 10% threshold, the likelihood of USD bond issuance diminishes. A $2.5 billion term loan, technically part of the $8 billion jumbo credit line, is also expected to be refinanced in full, with the remaining amortizations split between mostly MXN-denominated bonds and bank debt, potentially leading to local issuance as a means to alleviate the Hacienda’s role.
Investors have shown interest in Pemex’s debt in recent years, often due to its quasi-governmental status. However, mounting concerns about credibility and ESG issues have eroded investor confidence. It appears increasingly evident that only a comprehensive government-sponsored initiative will address the company’s financial challenges and restore investor confidence in the long run.
In the interim, the market is expected to adjust to the reality of “no new issuance,” though it will take time for support efforts to manifest in credit metrics and trading dynamics. Observers anticipate that front-end bonds will be met as scheduled, and the current curve inversion may eventually attract interest in the long end, correcting the prevailing anomaly.