The Long and Short
Mexico continues its Pemex ‘reorganization’
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Continuing the somewhat ambiguous process to address late payables to suppliers, the Mexican administration added some detail to the timeline of expectation for solving the long-standing payment delay yesterday in conjunction with officially signing the energy reform bill into law. With ambitions to “improve efficiency and attract private sector partnerships”, leading to improved production and lower gross debt, the administration – and Pemex management – continue to avoid detailing the step-by-step process to effectively do so.
Even the source of the planned $6.4 billion supplier debt paydown is not clear: is it an additional equity injection by the government or merely government assistance in factoring existing receivables to raise structurally senior debt meet the working capital shortfall? I suspect mostly the latter, though even if this is the case, the positive element of renewed operations with these key suppliers remains, thus supporting the recent reversal of spread behavior as investors anticipate further evidence of parental support.
Working capital pressures have plagued the Pemex balance sheet and cash cycle in recent years and thus the ongoing process is a clear positive in terms of governmental action to address balance sheet conflict that has led to operational disruption in recent months. The payment failures have had a destructive ripple effect on the supply chain, generating liquidity pressures across the network and forcing some of the larger suppliers to halt equipment and service provisioning, thus exacerbating the production issues for Pemex. The government plan to address overdue payments has been underway since December and I read the “Financial Market Operations” on page 31 of the recent earnings release as reflective of this.
While the corporate reclassification initiative may yield negative results in deemphasizing the Pemex-level incentives to generate profit or focus on governance practices, one could argue that limited strides were made on those fronts in general, in recent years. The potential positive is that formally bringing Pemex closer to the government provides more credibility to the state support thesis and the price reaction has reflected that, together with a general demand for liquid high yield risk that we have seen in recent quarters. This positive sentiment amongst investors has helped to drive the spread-to-sovereign differential to the tightest levels in recent years.
Amidst all of this, Pemex’ recent 4Q24 quarterly results were generally weak, with a $720 million EBITDA print illustrating a nearly 80% year-over-year decline as quarterly production languished (down 10% to 1.67 million bpd year-over-year) combined with the continuing challenge to add new fields to offset the older field decline rates and the Mexico Export Mix at $64.04/bl was 13% lower year-over-year. Further, the ongoing poor performance in the refining segment continues to burn cash, with all of the assets in the portfolio underperforming and causing Pemex to continue importing refined products, despite long-standing plans for “energy independence.” The approximately $7 billion in total (USD and MXN) credit lines remain nearly fully drawn and while available cash increased sequentially to $5.1 billion, the amortization schedule, which totals more than $20 billion through 2026 remains a clear miss match to available operational liquidity.
As such, discussions continue around the strategy for Pemex under its new classification and connected new fiscal regime: however, we are not expecting to see the full new business plan until the third quarter of this year. In the interim, initial details illustrate a comprehensive capex plan to improve production to 1.8 million bpd (which was the target for 2024 about a year ago and remains very ambitious for the current year, in our view) and also to rehabilitate the refining business together with targeted investments in petrochemicals and logistics. Operationally, production levels have generally trended lower in recent years with the Company having to lower its production targets every few quarters. Major fields like Cantarell and Ku-Maloob-Zaap are seeing steadily higher depletion rates, more than offsetting the capacity of the newer fields to compensate and maintain the total production level, never mind driving any material production growth. Though PPPs can add incremental production and cash flow, executing these agreements and generating cash flows are not immediate events and in total are not expected to contribute more than about 10% to the current production level, or around 165kboed. From here, arresting the production trend, meeting amortization requirements and stemming incremental cash shortages remain questions of capacity at the sovereign level.
There is thus the continuing debate around what is the next level of government support that will materialize during the Scheinbaum administration. The increasing drumbeat around a more formal support package, together with a recent uptick in demand for risk, have been fundamental to the recent spread tightening. Beyond the market yield deltas however, the strategic questions remain, with operating cash generation impossible at the current – albeit lower – tax rates while production growth have plateaued. As such, the market is also leaning into what new approaches a new administration may bring to the management of the credit. Under the new hydrocarbon legislation, the government may be able to borrow on behalf of Pemex to alleviate the supplier debt obligation and potentially also conduct LME at the Pemex level to address its growing amortization schedule and/or deploy cash to its upstream-focused capex initiative to arrest its ongoing production decline. While Pemex has generally resisted inquiries around new bond issuance, we continue to think that LME activities will be necessary to manage the maturity wall of 2025 – 2027. The sovereign budget has earmarked just shy of $7 billion for the company in 2025. However, the cash requirements beyond amortizations may siphon off some of this, adding to the need for incremental liquidity sources.
With the belly of the cap stack now below 10%—a previous threshold for issuance—Pemex could access the market to complement the broader government support strategy, potentially after the supplier debt situation has been addressed. While the Pemex / Sovereign spread differentials have traded to near multi-year tights, given the fiscal guard rails at the sovereign level, the potential for a wholistic solution appears low while a solution that mirrors past practice (the regular budgetary line-item commitment to meet Pemex amortizations) appears more likely in the near term. What follows are ongoing pronouncements of potential incremental action and support, to keep the market guessing (a la the AMLO strategy) as the Scheinbaum administration faces about $40 billion of Pemex debt maturities during its term, together with at least maintaining the current production level. While we viewed the sovereign-spread differentials in recent years as misaligned with fair value, the more positive market expectations currently are better reflections of fair value to the Sovereign and industry comparables. In the near term, progress on the supplier debt front is the next catalyst and we anticipate spreads to test tights as the (late) payables impasse has been substantially addressed in the coming couple of months.
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