José Coballasi
Senior Director
S&P
/
Insight

Predicting the Credit Ratings of CFE and PEMEX

Wed, 02/24/2016 - 16:22

If the energy landscape resembled a chessboard, CFE and PEMEX would ultimately hold the roles of the Queens, and as the strongest pieces in the game, they now move unfettered across the black and white milieu. The most renowned credit rating agencies, Standard & Poor’s Rating Services (S&P) and Moody’s Investors Service, have tracked the movement of these two key players and the roles they play in Mexico’s energy strategy. These two parastatals are now tasked with reinventing themselves into State Productive Enterprises and, given the enormity of this feat, some begin to question the security of their credit ratings, and whether or not they will falter.

Victor Herrera, Managing Director of S&P, is not so easily swayed by such opinions. “Financially speaking we will not see much difference, and it ultimately does not matter if they are state-owned. In fact, there are several state-owned companies across the world with a set of goals to achieve, and when these are not attained there are consequences.” This view is likewise echoed by José Coballasi, Senior Director of S&P, as he states that in the short and medium term, the ratings of both PEMEX and CFE are likely to align with those of the government. This conclusion comes from looking at other countries undergoing similar circumstances. “When we examine other markets such as Brazil, Petrobras and Electrobrás have important minority ownership and the ratings are aligned with those of the government.” Another example to highlight this perspective is Colombia’s Ecopetrol, which continues to hold first place in the market. As a result, one fact is incontrovertible for Coballasi, “National energy companies will continue to enjoy a position of leadership even as new players set up shop.”

In the past, CFE’s actions were confined since it could not sign bilateral contracts with an industrial client, but after the sweeping reforms, new mechanisms will now allow it to do so. In S&P’s eyes, CFE will continue to sign long-term contracts and many large players will opt for the PPAs in order to anchor the multimillion dollar investments they will contribute. Indeed, CFE’s contracts are attractive and bankable; however, according to Coballasi, the longevity and transparency of these terms remains a concern. “We have seen contracts in the private sector where there is more market risk. Nevertheless, this will not prevent projects from being developed. The government can facilitate the development of renewables and fashion PPAs that are aligned to the needs of producers,” he expands. CFE is arming itself with the best available tools; it will have the largest generation footprint, access to gas, and some of its facilities will showcase competitive PPAs. “CFE can now share the risk and offer more competitive terms to customers. The changes will allow CFE more commercial freedom,” Coballasi explains.

Having the best tools in the market is not enough, and in order for CFE to capitalize on new markets, it will have to provide cheaper and better services. At least this is what Nymia Almeida, Vice President Senior Credit Officer of Moody’s, believes. “CFE must be wary because everyone is eager to look for alternatives; CFE must reinvent itself,” she adds. In this new market all players are revamping themselves and CFE is no exception, as Alberto Jones, Director General of Moody’s, describes, “On the one hand you can imagine CFE competing fiercely with these players, and on the other you can envision CFE in a comfortable position of being the monopoly that is supported by the government.” For Jones, one aspect remains clear, the energy prices will ultimately drive the market and the players at the top will be those that can offer cheaper energy.

With this transformation, a question remains unanswered: how much of a challenge will it be for CFE to maintain its critical and overwhelming presence when competing against other players? In response, Jones stresses that CFE has been very diligent in the way it finances its operations. “We expect CFE to grow in a commensurate manner that is levelled with its commitment to society. From a risk perspective, its profile will improve over time rather than deteriorate.” For Moody’s, CFE is committed to growth and the new entrants must find additional value, especially in terms of the geographical regions where energy is urgently needed. “In terms of energy sources, the private sector will step in with its ingenuity and creativity and develop the most suitable technologies,” Jones adds. As the market unfolds, the position CFE will hold within it is a story that is ultimately yet to be written.

PEMEX is also busy figuring out its next business strategy. As some players in the electricity market appear puzzled regarding CFE’s next move, according to Jones, this is not the case in the oil industry. “The incumbent investors are serious bidders, so they already know how the market works. Basically, the industry has revolved around one player, which is PEMEX.” The burning question for investors seems to be centered on the likelihood of PEMEX filing for bankruptcy. “According to its by-laws, it cannot. However, there is the question of what will happen if PEMEX cannot pay. It is a difficult question to answer because it cannot file for bankruptcy, there is no facility for repayment plans,” according to Almeida. “This is a gray area at the moment, so as a result we are seeing new financing schemes related to the new position of PEMEX as a productive enterprise of the State,” she adds. In any event, new types of instruments are needed to help PEMEX fund itself without reporting this as debt, since the raise in debt is very much a concern that Moody’s and its investors share.

Regardless of new legislation, oil exploration and subsequent exploitation projects have always stood out as risky business ventures. For Herrera, all oil companies may lose money in their investments, but this comes with the territory. “Annually, PEMEX has been investing US$25 billion for the past seven years and still we continue to see a drop in production and persistently inefficient costs. If we begin to evaluate how much of that investment is used productively, we see the figures barely scratch 50%.” This shows that PEMEX is not as productive as other oil companies that are investing in other parts of the world. Now the NOC is given a chance to improve its performance across all processes. “Explaining failure in a billion-dollar project to stakeholders is a difficult task, and it is daunting to imagine doing so in front of Congress. Now that PEMEX can share the risk, its E&P segment can pursue opportunities more aggressively,” Coballasi comments.

CFE and PEMEX serve as two parastatal entities that are inextricably linked, and any miniscule change in one will be reflected in the other. “If only US$500 million of the US$25 billion that PEMEX spends are used to develop gas, then obviously CFE has no other option than to burn oil to generate electricity. This will dramatically change and we will begin to see a higher rate of investment in gas and thus more productivity,” Herrera expands. These two entities will now be able to offer contracts for the oversight of certain assets and this will generate many opportunities across value chains in all industries that need energy to operate. As these two parastatals strategize their next move across the shifting sands of the energy industry, one factor remains immutable, as Coballasi explains, “The more freedom these two entities are given in the operational side, the more aggressive they will become in the commercial side."