Gonzalo Monroy
Managing Director
GMEC
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GMEC Sees Stormy Year Ahead as Nationalist Rhetoric Takes Hold

By Peter Appleby | Wed, 09/30/2020 - 10:35

Q: What has been GMEC’s recent area of focus?

A: Recently, GMEC has been trying to forecast this administration’s future. At this point, given the contradictions within the administration and the nationalistic tone, GMEC is trying to understand what is driving its decisions, why these decisions are being taken and what the rationale is behind them. We are also hoping to understand what the government is trying to achieve and how they are likely to pursue this goal. On top of this, we are attempting to forecast the consequences of government actions for the people and industry of Mexico.

For example, the assault that is being made on the renewable industry could have been predicted from the start. It was clear to see that the federal government, CFE and PEMEX would take a more adversarial approach to private investment. Investing large sums into Mexico therefore implies a great deal of risk, and it is important that regional offices or emerging markets in Latin America have a better understanding of the situation here.

The most valuable service we, at GMEC, can provide my clients is my ability to go directly to the source. Due to our industry experience, including a former position at SENER, we are able to get the inside perspective by asking directly to our vast network of contacts in PEMEX, CFE or the government rather than waiting for a paper to be published.

 

Q: How do you rate PEMEX’s potential CSIEE service models?

A: The proposed new contracts do not align the incentives on offer with PEMEX’s aims. This is because PEMEX only earns money when hydrocarbons are produced. On the other hand, a number of companies are paid for the services they deliver to PEMEX regardless of whether production is achieved or not.

The problem with the CSIEE contract model is that service providers provide both the CAPEX and the OPEX. There is a lot of risk exposure for the service companies and few advantages. The contract would allow production on a fee-per-barrel basis and PEMEX would then market the production through PMI, which would not be the optimal method. From the money received, taxes would then be removed and, if money remains, service contracts would then be paid. Under this model, service contracts are effectively financing PEMEX while taking the commercial risk. Aside from Diavaz, there is no other company interested in the CSIEE model.

As a result, I expect that the contracts will be radically restructured before they are presented formally. This is particularly important because there is so much opportunity in the region’s other markets. This includes Argentina and the emerging acquisitions and consolidations in the US. Companies will question whether the risk is worthwhile, considering other business options.

Aside from this, companies will also be wary of financing PEMEX considering the NOC’s poor record of paying its contractors in the last few years. There is a lot of downside and very little upside for companies under the CSIEEs.

 

Q: How would you characterize the response from PEMEX and the national government to the negative pricing recently witnessed?

A: The first lens of analysis from this administration is always political. Politics comes first while the economy, and everything else, comes later. The administration has taken a “Make PEMEX Great Again” approach to the energy sector and has selected the revitalization of the NOC as the sole measure of success. They have pursued the lowest hanging fruits, which is sensible due to the low geological risk they pose, but it also means that returns have been low. This is an important point because to build a competitive and profitable operation, it must be of significant size and quality. When high-quality, large discoveries are made, they drive the development of infrastructure in the area. Without these factors, discoveries are less viable.

The administration’s aggressive and unrealistic plan to develop 20 priority fields and then have 20 discoveries that would be converted rapidly into production, set a goal of 40 discoveries and 40 commercial operations by 2024. This is not going well. A comparison against 2014 can be useful to explain this. In 2014, the Mexican oil basket was above US$110 per barrel and PEMEX’s CAPEX budget was some US$24 billion. During 2014, only five new fields were developed. In 2019, PEMEX had a US$13.5 billion CAPEX budget and the oil price was at US$49 per barrel, yet the company intended to develop 20 fields. This made no sense. Developing four times the fields, implying four times the amount of investment, with less money, has no logic.

As expected, a decline of the financial performance and operation of PEMEX has occurred. This is because the company’s business model is not working. It is unsustainable and will actually increase its losses, which, as a result, has hit the credit rating of the company. There are many prospective resources in Mexico that are not being exploited. These are the unconventional resources in Tampico-Misantla, which is huge in comparison to the Permian Basin in geological terms, and those in deepwaters. The industry is likely to experience a difficult environment going forward, which is being referred to as “lower for longer,” and the energy transition phase that has already started is likely to be a confrontation of sorts in the next administration. Mexico will need to decide between aggressively pursuing new developments supported by private investment or begin the conversation about stranded assets.

I lean toward the second idea due to the attack on renewables in Mexico, which is comparable to that of private investment into the oil industry. The administration has intended on capturing or destroying the regulatory agencies, thereby wiping out the credibility that these agencies had been building for so many years. This is especially relevant for CRE, which had 25 years of credibility flushed down the toilet. This new suspicion around the regulators will not be easily repaired. The increase in the number of Mexicans falling into poverty due to COVID-19 further decreases the attractiveness of the country to outside investment.

 

Q: How have the credit rating cuts impacted the attractiveness of Mexico for further investment?

A: The degradation of the investment climate is worrisome. The idea that the Mexican government does not respect contracts or could change the rules of the game as originally intended is raising questions over how much long-term investment will be put into Mexico in the future. There could be many long-term speculative opportunities, including bond issues, which have offered large premiums. But infrastructure investments, for example, are a different animal due to the length of time and amount of money required. For this reason, we are seeing developments in the oil industry’s secondary market with companies like Shell ceding portions of three blocks to Total while Qatar Petroleum purchased participation in Eni’s project. There will continue to be opportunity in Mexico but they will be different and perhaps not attract companies with such deep pockets.

 

Q: How can Mexico act to improve its storage potential and ensure energy security for the population?

A: President López Obrador says that the country should not be importing oil or refined projects because the country has the ability to pursue and fulfill its fuel demand itself. This explains the Dos Bocas refinery construction push.

At the same time, we can see that the government has an antiquated view of what energy security actually means. In the 21st century, energy security is the availability of fuel or energy at affordable prices. This is exactly what Mexico needs. It means nothing to an average person without gas in Guadalajara to hear the president say that fuel tanks are full in Tuxpan. It makes no sense. Instead, availability is key. Mexico does not have storage capacity outside of the three days in refined products and one and a half days of natural gas in some depleted wells in Veracruz and western Tabasco. Mexico could have developed depleted wells for use as oil storage and could, potentially, have avoided the impact of negative pricing the world recently experienced. Instead of exporting during negative and low pricing, PMI could have sent that oil to the national storage facilities if only they had existed. But Mexico does not have this cushion between the operation and demand necessary to avoid losses resulting from these sorts of situations.

On top of this, we must remember that in order to save PEMEX from some penalties, the administration decided that the whole storage policy being pursued to increase Mexico’s storage capacity to 15 days should be reduced to only five days. This was to the sole benefit of PEMEX. Rather than pursue a grand strategy to bring benefits to Mexico and its people, the government has mistakenly seen PEMEX and Mexico as one and the same thing. This has been a mistake.

 

Q: What issues will Mexico’s industry be grappling with over the next year?

A: There are a few issues. I would distinguish between the companies that already have contracts in Mexico and those that do not. For those that have contracts, it is likely that there will be a slower pace of developments. There is no rush for operators because of the current environment, except for Eni, for whom it makes sense to have a fast-track development. Prior to COVID-19, Eni was developing its field to sell it to another operator. But in the depressed market, it is unlikely that Eni will find a reasonable suitor.

Those companies without contracts in Mexico will wait to see what the administration does before committing here. A number of investors, including those abroad, believe the administration will come around once they realize that there is no amount of public investment available that can offer a financially-sound strategy to pursue. The government may become more pragmatic and reduce the severity of the ideology they have been espousing. There is also another camp that sees further degradation of investment quality in Mexico and are therefore trying to see whether the current government thinking is a momentary blip or an ongoing strategy. There is no reason for companies to develop opportunities in Mexico if they do not feel confident of the national situation when there are such good opportunities in other countries of the region, including Brazil or Guyana.

 

GMEC is an energy consulting firm specialized in providing business intelligence and insights across Mexico’s oil and gas and renewables markets. The company provides services to both national and international energy companies and investors.

Peter Appleby Peter Appleby Journalist and Industry Analyst