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Pemex set to struggle with lower oil prices due to coronavirus

Bnamericas Published: Monday, March 09, 2020
Pemex set to struggle with lower oil prices due to coronavirus

In what may come to be known as Black Sunday to investors, oil spot prices dived by more than 20%, triggering a new wave of sales on stock markets due to fears that coronavirus will affect world economic growth. 

Mexico’s iconic national oil company Pemex and even the national budget are uniquely vulnerable to sustained declines in global oil prices. 

“An economic slowdown will throw the price of oil to barely profitable levels, and that, including the price war between Saudi Arabia and Russia, could be really negative for Pemex,” Luis Gonzali, vice president and senior portfolio manager at Franklin Templeton Investments in Mexico City, told BNamericas.  

Over the weekend, Saudi Arabian NOC Aramco, now the most valuable listed company in history, cut its official oil prices. In tandem, the country’s government announced it was planning to increase oil output. 

The move was an unprecedented salvo against Russia, after Moscow last week refused to go along with OPEC plans for price cuts amid concerns that the coronavirus was quickly eroding demand for oil. 

At one point, oil prices dropped to US$27 a barrel overnight, before recovering to US$32 on Monday. 

Now, Russia’s refusal to back OPEC’s plans and Saudi Arabia’s historic response has ignited a price war between the world’s second- and third-largest oil producers, with cascading effects on smaller producers like Mexico. 

“While Pemex contracted an oil hedge for part of its production, it did not cover all of it; and if it triggers the hedge, the coverage will be paid at the end of the year, so it will have to wait all year with depressed income,” Gonzali said. 

The Mexican government’s budget, meanwhile, pegs revenue based on an average of US$49 a barrel through 2020. 

IMPACTS ON MEXICAN BUDGET

Gonzali pointed out that depressed prices will have knock-on effects for Mexico’s national budget, which itself relies in part on the government selling oil. Mexico’s sensitivity to global oil prices has led the finance ministry (SHCP) to take out options contracts to effectively lock-in prices each year since 2001. 

“The oil hedge for the federal budget is complete at US$49 [a barrel],” Gonzali said of the 2020 budget, noting that if Mexico exercised the hedge it would only pay out at year’s end. In 2019, it hedged the price at US$55 a barrel. 

Though the hedge has been exercised only three times from 2001-2019, it has generated enough income on those occasions to pay for the overall cost of the program. 

But while the program has proven successful, the oil hedge has become controversial of late, and President Andrés Manuel López Obrador's government has tried to curtail disclosures. In January it moved to deem details about the oil hedge a “state secret.” 

Should coronavirus fears lead to a prolonged economic slump this year, SHCP has managed to mitigate the worst effects through its use of the oil hedge. 

However, the impact on oil prices would be only one of many headwinds that Mexico could face. A weaker peso in currency markets would likely buoy Mexican exports, but a slowing economy would mean lower revenue for the government. 

“The effect is mixed,” Gonzali explained, “however, I think that in aggregate a global deceleration would be negative for the budget.”

Pemex has yet to publicly announce plans on how it will operate if oil prices remain near current levels. The world’s most heavily indebted oil company, Pemex faces soaring pension costs, and the government’s demand that it dramatically lift output has it mid-stride in a turnaround plan based around bringing online “20 priority fields.” 

However, only four of those 20 fields are producing oil. And even if all of them were productive, the 20 fields would have a breakeven cost of US$52 a barrel, according to an analysis by Natural Gas Intelligence last November. 

For Pemex, the short-term threat is that it has not hedged its total production, leaving it somewhat exposed if global oil prices remain low throughout the year. More ominous still, even if the company manages to get its 20 priority fields online in the coming years, they could prove unprofitable. 

Meanwhile, the government is facing mounting pressure to combat public health concerns related to the coronavirus alongside broader economic impacts of fewer tourists and lower oil prices. 

“In this sense,” Gonzali said, “I think that the government will opt to implement spending cuts, instead of greater debt.”

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