Why AMLO's Plan to Revive National Oil Firm Is Worrying Investors
WHY YOU SHOULD CARE
Plans to revive the country’s debt-laden public oil firm are leaving international investors anxious.
By Colby Smith
International investors have given a thumbs-down to Mexico’s plan to revive its debt-laden state-owned oil company, Pemex, a move that has confirmed their unease about the country’s policy direction under the populist leadership of President Andrés Manuel López Obrador.
In the hours after the government of Latin America’s second-largest economy announced how it will transform “an oil industry in ruins” and shore up Pemex to “contribute to developing Mexico” eventually, the peso dropped almost 1 percent against the dollar, before recouping some of its losses. Yields on bonds issued by the government and Pemex also spiked, indicating a fall in price, while the cost of insuring against the oil company defaulting remained elevated, near levels not seen in three years.
The market reaction turned swiftly negative because few investors are convinced the plan does enough to fix the indebted company’s most pressing problems and, more importantly, stave off another downgrade from credit rating agencies. In June, Fitch Ratings cut Pemex’s rating to junk.
“It’s likely buying a couple of years’ time for Pemex,” while doing little to avoid another downgrade by year-end, says Yerlan Syzdykov, global head of emerging markets at Amundi Asset Management. Until that credit event happens, however, Syzdykov says he would steer clear of the Mexican market.
López Obrador’s plan includes $6.7 billion of much-needed tax relief in 2020 and 2021, with nearly $16 billion of additional support coming directly from the government, the private sector and the oil company itself next year, according to a government presentation.
In 2021, total investment will increase to nearly $22 billion, to keep pace with the government’s goal of increasing oil production from today’s historically low levels, which are forecast to average 1.7 million barrels a day in 2019, to 2.61 million barrels a day in just five years.
While the fresh funds will help tackle Pemex’s $100 billion-plus debt load, investors take issue with other facets of the plan, including the limited role designated to private investors. Causing the most consternation, however, is the government’s insistence on pushing ahead with a Pemex-led $8 billion refinery project in Dos Bocas, in the southeastern state of Tabasco, which the private sector doubts can be built to budget within the government’s three-year time frame.
“There are too many red lines now,” says Kim Catechis, a portfolio manager at Martin Currie. “The government has drawn a red line on private sector involvement and a red line on the refinery, so you’ve ended up with a suboptimal plan.”
The plan to rescue Pemex follows the unexpected departure of Carlos Urzúa after just seven months leading the Finance Ministry. In a scathing resignation letter, Urzúa denounced López Obrador for formulating an economic policy without sufficient evidence, as well as putting in place “officials who don’t know about public finances.”
“The resignation is a big, bad flashing warning signal,” says Catechis, who has already wound down some of his positions in Mexico and expects at least one sovereign downgrade in the next six to nine months. “Stay in at your own peril.”
For Alejo Czerwonko, an investment strategist at UBS Wealth Management, the flare-up between Urzúa and the Mexican leader is unsurprising: The former is a respected technocrat with a solid record of eschewing fiscal profligacy; the latter is a leftist president who rails almost daily about the neoliberal policies of the past 40 years that put the market first.
“The resignation is really a product of Mexico’s worsening policy mix since [López Obrador] took office,” says Czerwonko. “[His policies] are incompatible with the more orthodox, better-trained members of his administration.”
López Obrador’s move as president-elect to cancel the completion of a $13 billion airport in Mexico City that was already one-third built stirred controversy with investors early on. However, Urzúa was able to shore up market confidence, with the unveiling of a fiscally prudent budget in December. The spending plan promised a 1 percent surplus in 2019, which his successor, Arturo Herrera, says will be met.
But some investors worry Mexico will start to slip on its fiscal targets — especially as the economy teeters toward technical recession. Mexico’s debt remains in investment-grade territory for now, but investors fear a crisis could spiral.
“Mexico and Pemex are … tied at the hip,” says Anupam Damani, a portfolio manager at Nuveen. “The Mexican government is facing an impossible trinity of trying to manage fiscal prudence at the state level, having to support and make Pemex sustainable and fund [López Obrador’s] social welfare agenda.”
For the country’s outlook to turn more positive, Alberto Bernal, a strategist at XP Securities, says he needs to see “a complete change of ideology from the government.” That means welcoming foreign investment into the energy sector, among other market-friendly policies.
“I don’t feel like the government is sending that message,” Bernal says. “My only hope is that at the end of [López Obrador’s] tenure, the country has not deteriorated too much.”
Additional reporting by Jude Webber in Mexico City.
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