Pemex Suffers an Old Problem in a New Oil Market

(Bloomberg Opinion) -- As the global oil industry zigs, Petróleos Mexicanos zags with all it has. And zagging really isn’t working for it.

Not that this is all Pemex’s fault. Far from it. The state-owned national oil company has long been a piggy bank for the government, albeit with the important distinction that, unlike many other piggy banks, it never gets fully replenished. Hence, President Andres Manuel Lopez Obrador was forced Tuesday morning to pledge more (as yet unspecified) aid for the company in coming days. Hence, also, the subsequent jump in Pemex’s bonds belies the structural problem here.

AMLO’s announcement came after last week’s package of $3.5 billion of tax cuts for Pemex, spread over six years, met with a Bronx cheer from the bond market and Fitch Ratings, which cut the company’s credit rating to the edge of junk. And really, you can see why. A tax holiday worth less than $600 million — or about 11.4 billion pesos — a year rather pales in comparison to what the government has historically siphoned off:

Supporting not merely its own operations but also a substantial chunk of public spending, Pemex hasn’t had the wherewithal to invest in itself or keep its balance sheet in good shape. The company hasn’t had positive free cash flow since 2007, according to figures compiled by Bloomberg, whether oil was at $100 a barrel or $30. Net debt spiraled from 0.5 times Ebitda in 2007 to more than 7 times at the end of 2017. That has since declined to a merely awful level of just above 5 times. Oil and gas production, reliably north of 4 million barrels of oil equivalent a day a decade ago — similar to Exxon Mobil Corp. — fell to about 2.5 million a day in the 12 months through September 2018.

This combination of high debt, falling production and negative free cash flow is the antithesis of what investors demand from a typical oil major these days. Of course, Pemex isn’t a typical oil major, and its shareholder, the Mexican government, has priorities that tend to rank above whether the company’s return on capital benchmarks well with others. National oil companies, even partly listed ones, always serve two masters, and the one that appoints their executives tends to hold the edge.

What we are now witnessing with Pemex is an example of what happens when the social burden on a national oil company finally starts to overwhelm its ability to also maintain itself as a functioning commercial enterprise. To the south, a far more extreme version is playing out with Petróleos de Venezuela SA. That disaster also reflects a broader political breakdown. But Pemex is also a victim of short-termist and muddled policy. Growth plans, in line with AMLO’s goals for Mexican oil and gas production, stand in direct contrast to another goal: repairing the state oil company’s finances.

This mismatch of Pemex’s capabilities and obligations is a long-standing problem. What makes things different now is the changed environment in the global oil market. There is a reason why listed oil majors make a point of trying to live within their cash flow and talk about returns rather than growth. A striking aspect of Chevron Corp.’s results announcement last week was its boast that 70 percent of its capital expenditure budget would start paying back in cash terms within two years.

In part, this is a response to a backlash against poor investment decisions across the industry over the decade leading up to 2014. Yet it also reflects a growing discomfort with the idea of companies investing billions in multi-decade projects at a time when many question the prospects for oil demand beyond 2030 or so. In a recent survey of institutional investors, the Oxford Institute for Energy Studies found expected hurdle rates for new conventional oil projects had risen appreciably compared with historical rates of return, as investors priced in the risks of the energy transition.

Most pertinently for Pemex, the expected hurdle rate for megaprojects in emerging markets came in at 21 percent, well above historical levels of around 13 or 14 percent. Having large oil resources was an economic trump card for petro-states when both demand and prices were expected to keep rising ad infinitum in a hopelessly addicted world. As an assumption, it led Saudi Arabia astray in its expectations for the (still AWOL) IPO of Saudi Aramco, and it is now pressing down on Mexico at a national level. Whether or not AMLO shuffles this or that amount from one side of the public ledger or another may alleviate a short-term crisis but likely won’t deal with the fundamental problem. What counts now is cash, not barrels.

To contact the editor responsible for this story: Mark Gongloff at mgongloff1@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal's Heard on the Street column and wrote for the Financial Times' Lex column. He was also an investment banker.

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