PEMEX: The Need for Reinvention

The long-standing petroleum culture of the oil monopoly in Mexico has always taken for granted that PEMEX must not only explore and extract crude oil, but also refine it into petroleum products.

This is not necessarily the case. Exploration and production (E&P) and refining are two distinct and differentiated industries. The discovery and exploitation of hydrocarbons involves geosciences, soil and fluid mechanics, while refining is mostly about chemistry. In terms of the internal rate of return of investments, exploration and production is definitely a winner with an average return of around 37%, while refining has an average return of 8% when the business is properly managed. In terms of marketing, exploration and production is always subject to international oil prices, to volatility and shocks that respond to crisis and bottlenecks; while refining depends on the oil price, and is subject to extreme volatility, thin margins, seasonality and a complex geographic market environment. 

Exploration and production generates the economic rent that derives from the exploitation of a natural non-renewable resource where, since the Napoleonic Code, the state holds an original right, compensated through the payment of royalties. Refining does not generate economic rent, and having a monopoly in refining is a challenge to say the least. It is mainly a challenge to the state-owned company, which must operate under the constraints of a national state and is expected to satisfy the total internal consumption of the country, even if it does not make financial sense.

In the case of Mexico, exploration and production has been a success story, providing for many years an economic rent that has contributed significantly to government finances, while reporting substantial net income results. This means that E&P has been good for the country, and also good for the long-term sustainability of PEMEX, the state-owned company. On the other hand, refining has proven to be complex to manage in a monopolistic environment. Refining today is as challenged as it has ever been. Regarding the goal of providing competitive and sufficient fuels to the Mexican market, the PEMEX refining arm has not been successful. The cost of producing a barrel of fuel in Mexican refineries is significantly higher than in international counterparts, while refineries are producing at 50% of their capacity. Mexico as a country has been increasingly importing fuels from abroad to satisfy the needs of the local market. 

From a financial perspective, PEMEX Refining (now known as TRI) has consistently been in the red, and it tripled its financial losses in 2020, 2021 and 2022. We must highlight that this is the Achilles’ heel of the company, and the very reason the government of Mexico has had to financially support PEMEX, aside from the historical debt that was not acquired by this administration. 

Between 2018 and 2022,TRI’s total net income has been negative, at MX$756.13 billion (US$45 billion) ; this is higher than the total capital contributions that the federal government has assigned to PEMEX in the same period, which add up to MX$720 billion (US$43 billion). In other words, the financial losses of TRI have more than wiped out the great effort of the Mexican government to rescue PEMEX.

Refining is a complex business, particularly in a monopolistic environment. Of particular concern is the very high level of fuel oil production, which in the case of Mexican refineries. This accounts for more than 30% of total production of fuels, while it’s marginal in the rest of the world. Fuel oil used to be the main source of primary energy for the generation of electric power, but a profound conversion of Mexico’s energy grid has drastically reduced the demand for fuel oil. Additionally, fuel oil is no longer accepted as a marine fuel. 

Based only on the financial viability of PEMEX in the long term, it is clear that refining operations are a burden for the company. PEMEX must make a decision sooner than later, and it has two choices: shut down completely or sell the refining operations, therefore improving the financials of the company; or implement a comprehensive revamping program, that would require a very large investment. This investment would be provided by a strategic alliance with a seasoned refining operator with proven success in other parts of the world. It is unlikely and unadvisable for the government to embark on the type of investment that is required to revamp the National Refining System, if it wants to maintain healthy public finances.

PEMEX is not only “too big to fail;” it also plays an important role in the Mexican economy, and it could transform itself into an efficient, competitive oil and gas company, not only providing economic rent, but also contributing to the cost-effective and timely supply of fuels required by the country’s economy. Its demise could be much more costly, not only for the government, but also for the country as a whole.