The Obscure Rule Change That Added $5.7 Billion to Pemex's Books

(Bloomberg) -- A $5.7 billion earnings bump that retroactively turned Pemex’s $1.8 billion fourth-quarter loss into a profit almost didn’t occur at all.

The reversal of fortune was quietly introduced to the public when the Pemex CFO surprised listeners on a May 3 conference call by identifying the company’s first-quarter profit as the second in a row.

A Petroleos Mexicanos regulatory filing offered just a hint as to what happened. For 10 months, Pemex failed to recognize the import of a government ruling designed to boost the value of its reserves, the filing shows. The Mexican oil producer only took advantage of the new rule after outside auditor Castillo Miranda & Compania S.C. reviewed its final 2016 status.

The rebooking, coming months after the earnings were initially reported, was needed because of “a failure of our internal controls to include a mechanism to ensure that the period allowed by the authorities is properly applied,” the company wrote in the filing. Pemex concluded that "a material weakness existed in our internal control over financial reporting."

"It’s a pretty big oversight to just look past that rule change,” Tim Samples, a law professor and Mexican-energy analyst at the University of Georgia in Athens, said in a telephone interview. “It’s not a great look for your management and your accounting."

To avoid this happening again, Pemex will implement a remediation plan to assure updated regulatory criteria are incorporated into future financial reporting, according to the filing.

More Time

The rule change by the National Hydrocarbons Commission came on April 15, 2016, in the form of a modification to an agreement reached after the government opened the energy industry to outside investment in 2014, the regulator said in an email. That allowed state-owned Pemex to book reserves for 25 years, instead of just two, on as many as 72 fields it was charged with maintaining after the government opened the market.

The longer lifespan turned reserves the company had written off into assets again, Pemex said in a response to questions.

That, according to Pemex, explains the 105.3 billion-peso ($5.7 billion) difference between a 72.7 billion-peso profit now booked for the fourth quarter and the 32.6 billion loss that had been previously reported. Before that, the last time the company had a profit was the third quarter of 2012.

Chief Financial Officer Juan Pablo Newman mentioned the change, in passing, during the call to discuss the company’s first quarter 2017 report. Alejandra Leon, an analyst at research firm IHS Energy in Mexico City, was among those on the call who wasn’t expecting that.

Big Discrepancy

It is “surprising that there is that much of a difference,” she said in a telephone interview. “Generally there are adjustments between the first report and the audited one, of course, but this one is enormous.”

The oil fields covered by the accounting change are likely to be auctioned to other drillers. When that happens, they’ll be taken off the company’s books and Pemex will no longer be required to operate them.

Some of the fields originally assigned to Pemex had already been auctioned in 2015 as part of a government effort to boost production in the country while reducing the financial burden they represent for the company, given its reduced exploration and production budget.