Oil Prices and Mexican Peso Drop SharplyBy Jeroen Posma | Mon, 03/09/2020 - 12:32
Oil prices collapsed on Sunday March 8th after Saudi Arabia launched a price war. Last Friday, OPEC and Russia failed to reach an agreement on a 1.5-million-barrel production cut until the end of the year that resulted in a same-day price drop of 10%. Two days later, Saudi Arabia’s announcement of a price cut for all its mayor markets, accompanied by an upcoming production increase, pushed oil prices down by more than 30 percent, the worst one-day crash since the first Gulf war in 1991, to reach US$27 before recovering to US$32 by noon in Mexico City. The outlook of a prolonged oil price war, increasing production and a drop in demand as a result of COVID-19 create a perfect storm that could see oil prices drop to US$20 per barrel according to Goldman Sachs.
Stock markets plummeted around the world, with trading the S&P 500 halted for 15 minutes after a rapid 7 percent plunge in early trading followed by a slight recovery that left the market 7 percent down. By noon, the market once again was 7 percent down after a brief recovery. Share prices of oil companies with exposure to Mexico were down by 10 percent for ExxonMobil, 17 percent for Shell, 19 percent for BP, 21 percent for ENI, 25 percent for Fieldwood Energy, and 30 percent for Talos Energy. Major oilfield services companies Halliburton and Schlumberger saw their share price drop by respectively 37 percent and 29 percent, while the source of the market crash, Saudi Aramco, saw its share price drop by 5 percent.
While PEMEX is not a listed company, it will be among the companies hardest hit by the drop in oil prices. After almost doubling its net loss to MX$346 billion (US$18 billion at the average 2019 exchange rate) in 2019, accompanied by a drop in oil production from 1.82MMb/d in 2018 to 1.68MMb/d in 2019, PEMEX’s financial position and cost structure leave it ill-prepared to weather the drop in prices. Despite the fact that PEMEX’s oil production reached 1.78MMb/d on December 31, and increased to 1.82MMb/d by the end of January, the need for structural change aimed at reducing cost and improving efficiencies is more urgent than ever in the current oil price scenario.
PEMEX’s total debt stood at US$105.2 billion last year, including increasing dept to service providers that reached US$9.8 billion, leaving little room to take on additional dept to weather the storm. Despite the fact that credit ratings agencies have warned of the risks associated with the company’s high debt load, the Lopez Obrador administration is investing heavily in the company’s loss-making refining activities while success in improving the performance of its upstream activities is behind schedule. Fitch Ratings already downgraded PEMEX’s debt to junk status, which leaves the company’s bonds at risk as a downgrade by another major rating agency would trigger a forced sell-off by investment funds.
On the bright side, Mexico has long been making the world’s largest sovereign oil hedge. Although not all details of the 2020 hedge are clear, the country is expected to have hedged 200 to 300 million barrels at a confirmed oil price of US$49. This investment of around $1 billion, according to Finance Minister Arturo Herrera, is destined to pay off handsomely as the Mexican crude oil basket price dropped from US$40.32 per barrel on Thursday, March 5, to US$35.75 per barrel the following day. Based on this morning’s dramatic drop in oil prices, the Mexican crude oil basket price may close below US$30 per barrel to. The oil hedge is expected to safeguard 4 percent of the country’s GDP.
Despite this oil hedge, Mexico remains acutely exposed to oil prices. Just like the currencies of other oil-producing and exporting countries, the Mexican peso exchange rate was moving too quickly for comfort, with the value of the dollar touching MX$22 before settling around MX$21.2 by noon Mexico City time. This ends three years of relative stability where the dollar’s value hovered around MX$19, and places the current exchange rate on par with its weakest standing of the Mexican peso against the US dollar recorded in January 2017. Russia, the target of Saudi Arabia’s oil price war, saw the ruble drop 8.5 percent against the dollar.
While Mexico was relatively slow to feel the economic impact of the COVID-19 pandemic, the steep drop in oil prices and the Mexican peso just made things a lot worse. While former Goldman Sachs CEO Lloyd Blankfein tweeted this morning that he believes that fear has taken the market lower and that he expects a quick recovery once the COVID-19threat recedes, it might be wise for Mexico to brace itself for the prolonged impact of these recent events on its economy.