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AMLO risks his own fall as he tries to pull Pemex back from the brink

Alejandro Cegarra/Bloomberg

Andres Manuel Lopez Obrador

- President offers tax breaks in bid to end company's long slide

- Indebted oil giant could drag down Mexico's ratings: investors

By Eric Martin and Justin Villamil / Bloomberg

Petroleumworld 03 21 2019

Pemex is personal for Andres Manuel Lopez Obrador, who grew up in Mexico's oil heartland at a time when the state company was a source of national pride.

Now that he's president, the leftist leader has made it a priority to pull Pemex out of a two-decade slump . Investors are worried that the opposite could happen, with the company dragging Lopez Obrador down instead, and the economy with him.

Petroleos Mexicanos, the company's full name, is already the world's most indebted oil major, owing about $108 billion. AMLO needs to cut that debt, while boosting investment and output. His solution? Slashing taxes on the company that has been a cash cow for the state for decades. The market concern is that he will fail to restore Pemex to profitability (it's been in the red since 2012), while opening a black hole in the government budget.

“Serious trouble at Pemex can be truly toxic for sentiment and the broader economy, and would contaminate the sovereign balance sheet,'' said Alberto Ramos, the chief Latin America economist at Goldman Sachs Group Inc. in New York.

Lopez Obrador's predecessor tried to turn it around by opening the door to private and foreign investment. The plan failed to halt a 14-year decline in output, which reached a record low of 1.62 million barrels a day in January. Lopez Obrador has since halted the project.

‘Truly Toxic'

Pemex could threaten Mexico's hard-won reputation for sound finances -- and pass on higher borrowing costs to its global businesses, like cement maker Cemex SAB or billionaire Carlos Slim's phone carrier America Movil.

The central bank, for one, is worried.

Pemex was barely mentioned at interest-rate meetings last year. But that changed after the company's credit score at Fitch Ratings was lowered by two notches in January –- taking it to the brink of junk status.

At the latest meeting in February, a majority of policy makers warned of the wider risks posed by Pemex's financial fragility. They said another downgrade could hurt the federal government's ability to borrow. Mexico is already expected to lose its investment-grade sovereign rating in “upcoming years,'' according to almost 70 percent of respondents in a Bank of America survey .

‘Built in a Day'

There's a common perception among investors that the oil company's bonds are backstopped by the federal government, its sole owner. In the absence of default, the premise has never been tested, even as Pemex piled up debt. It routinely ranks among the biggest emerging-market bond issuers, and has $5.3 billion of payments due by the end of May.

The company says it expects output to pick up in 2020, after another decline this year. It's working to control spending and trim leverage, Chief Financial Officer Alberto Velazquez told investors last month. “Rome wasn't built in a day,'' he said.

Jaime Reusche at Moody's Investors Service says Lopez Obrador is taking a fiscal risk by committing to prop up the company at the same time as embarking on ambitious social and infrastructure plans.

He won election by a landslide last year by vowing to end decades of below-par economic growth that left half the population stuck in poverty. He's promised higher pensions and student allowances, and new railways – all without significant tax hikes.

Viable Plan?

Pemex is getting its share. Last month, Lopez Obrador announced a package including an extra 24 billion pesos ($1.3 billion) in tax breaks over six years.

The peso weakened in response, on concern that the measures might be a step in the right direction -- but fell short of a viable business plan.

Lopez Obrador favors boosting investment in onshore and shallow-water production, which has quicker but smaller returns than the deep-water and non-conventional exploration favored by his predecessor. He has also embarked on a crusade against fuel theft , which costs Pemex some $3.5 billion a year, and other forms of corruption. He plans to build a new refinery that almost all analysts see as an expensive white elephant.

The direct economic impact of whatever transpires at Pemex may be limited. Oil and gas contributed just 3.4 percent of GDP last year, less than half the level of 25 years ago -– a reflection of the company's decline, as well as the growth of other industries like autos.

Still, it's the country's second-largest employer after Wal-Mart, with almost 130,000 employees. And it's a big contributor to the budget. Over the past two decades, 95 percent of Pemex's profits went to the government – a bigger share even than Venezuela's state oil company, according to Capital Economics. Last year, it contributed one-fifth of the tax take.

There's a case for easing that burden -- as AMLO is doing -- according to Shamaila Khan, director of emerging-market debt at AllianceBernstein in New York. But the move could backfire.

"Mexico has to give some support to Pemex, and take less money," said Khan. The problem is, "that adds up to more fiscal pressure on the country."

— With assistance by Amy Stillman


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Story by Eric Martin and Justin Villamil from Bloomberg. 03 20 2019


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