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Mexico swims against the tide

Reviving bidding rounds seems the rational answer to the country’s upstream woes. But the government remains defiant for now

Mexico is rapidly becoming a global exploration hotspot. Spanish operator Repsol announced two major new oil discoveries in early May, while in February Italy’s Eni made its own significant find. Private companies operating in Mexico plan to drill half of all Latin American exploration wells this year.

But while there is clear interest in the country’s offshore potential, the government’s upstream strategy is puzzling. All bidding rounds for new acreage remain shelved, and Mexican President Andres Lopez Obrador has shown little interest in restarting them, despite the low financial risk for the government and the majority share it will receive from any oil produced.

Unlike Brazil, which has rapidly developed its deepwater discoveries through IOC assistance, Mexico is focused almost solely on shallow water. State oil firm Pemex is attempting to lead a Mexican upstream renaissance through the start-up of 22 new fields, but all except one are in shallow waters. The government aims to achieve a 1mn bl/d increase in output by 2024, funded mostly by Pemex.

Financial woes

But the government’s plan was looking dubious even before Covid-19 sent markets reeling. Oil field start-ups have slipped behind schedule, while Pemex posted a $7bn net income loss in the fourth quarter.

This year is looking even more ominous. Pemex reported an enormous $23bn net income loss in the first quarter, largely due to currency devaluation and plummeting oil prices. The value of Mexican crude exports dropped by 38pc year-on-year in the quarter, to average just $40.90/bl. Global demand for heavy, sulphurous crude was already on a downward spiral, but national lockdowns have only accelerated the trend.

And the downstream sector has suffered even more than the upstream. “The first quarter was one of Pemex’s lowest refining margins in recent history, lower than -$12/bl,” says Edgar Cruz Borges, head of credit research at Spanish bank BBVA. “No other company in Latin America that I know of has such bad numbers.”

“No other company in Latin America that I know of has such bad numbers” Cruz Borges, BBVA

Added to that, Pemex’s total debt increased by 24.2pc during the first quarter. Today it sits at $104.8bn, despite the government pledging not to increase the figure over the next few years.  

The company’s credit rating was downgraded to junk by several agencies as a result. Without access to credit, the government will likely be forced to extend further cash to Pemex over the near term. “At current oil prices, debt is manageable only with further government injections, as seen in 2019,” says John Padilla, managing director at consultancy IPD Latin America. “Pemex’s access to debt markets has virtually been erased after the latest round of downgrades.”

Digging their heels in

Against this financial backdrop, the government is sticking firmly to its upstream plan. During the most recent Opec+ meeting, Mexico doggedly refused to make substantial cuts, only reducing national production to 1.681mn bl/d. After recalibrating for March figures, which came in lower than expected, Mexico actually pledged to remove just 65,800bl/d—much lower than the publicised 100,000bl/d.

The reality, however, is that most of Pemex’s production is rapidly losing money. “Mexico had a golden opportunity to cut c.400,000bl/d of uneconomic production from its portfolio tail,” says Pablo Medina, vice president, research, at consultancy Welligence. “At $35/bl Brent, over 80pc of its fields are cashflow negative. Lopez Obrador could have saved face by saying he really wanted to increase production, but then agreeing with the Opec+ cuts and changing policy goals.”

$104.8bn – Pemex total debt

And with start-ups slipping behind schedule it is difficult to see how Pemex can meet its production ambitions alone. The company was expecting to produce 75,000bl/d more at this stage than it actually is, says Medina.

Further drilling campaigns offshore Mexico are planned this year from IOCs including Repsol, Shell and UK-headquartered Cairn Energy. If Mexico were to restart bidding rounds it would help reduce Pemex’s financial burden and increase the prospect of more oil projects starting up.

Mexico rapidly needs more diverse sources of production to achieve 2.7mn bl/d by 2024, and IOCs offer the deepwater expertise that Pemex lacks. “Mexico needs private companies to maximise the oil sector’s potential,” says Medina. “The benefits of licensing rounds are clear and everyone wins. Pragmatism should lead the way.”

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