Pemex – Caught between a Rock and a Hard Place

RelevanceMexico makes for a rather sorrowful case study in the history of natural resource extraction. The country is rich in oil and gas, and yet due to mismanagement it is importing large quantities of gas from the U.S. by pipeline and from elsewhere via LNG. If the current rate of oil production decline and economic growth are maintained, it will not be that long before Mexico will have to import oil as well. Pemex remains one of the very few remaining, traditional “resource protector” national oil companies. It is over taxed, carrying a high debt burden and does not have the technical nor project management know how to take advantage of the potential that deep water Gulf of Mexico (for example) offers. As Pemex struggles to make the most of a dire situation, there is no sign of the necessary political intervention that Mexico needs. Absent of an economic or political crises to spur change, such intervention seems as far away as ever.

AnalysisPemex operates under a tax regime that was designed for low cost, onshore exploration and production. This regime is not suitable for exploiting mature fields or more costly opportunities such as Chicontepec or deep water. This system has been bad for both Pemex and Mexico: 

  1. Pemex has buckled under the financial burden imposed by tax (as demonstrated by its very unusual negative shareholder’s equity reported on its balance sheet). Pemex has also borrowed heavily to finance its exploration efforts, and now has a credit rating close to speculative grade.
  2. Mexico has come to rely heavily on the tax that Pemex pays. Pemex tax represents about 30% of all government revenues.

Pemex is one of the few traditional “resource protector” national oil companies left in the world. This is a world where opportunities for the international oil companies to invest are becoming fewer (largely due to the increased role that NOCs are playing). Mexico needs the IOC’s capital and technology, and IOCs need new opportunities. Surely this would be a perfect match?

Unfortunately not. Listed below are the possibilities for Mexico and Pemex to increase investment and, unfortunately, all of them look unlikely at the current time:

  1. Tax. The most obvious and immediate remedy would be for Mexico to significantly lower the Pemex fiscal burden. One change was made in 2005, resulting in $2B lower taxes. Politics dictates that further reductions are unlikely, and this solution does not address Pemex’s technology gap.
  2. Privatize Pemex. This would bring IOC capital and technology. Surprisingly, partial privatization has been raised before. Several years ago a bill was drafted, but got no further. It is highly unlikely that this proposal will be resurrected any time soon.
  3. Open market to foreign competition. Providing access to Mexico’s hydrocarbon resources (under a tax and royalty or PSC arrangement) to outside investors would generate no end of suitors. It would also help to improve Pemex’s performance, as the company would be subject to increased competitive pressure. It would also allow IOCs to book reserves, a prerequisite for many.
  4. Extend the MSC concept. Pemex has already has success attracting foreign know how and investment to the Burgos gas fields through Multiple Services Contracts. Companies such as Repsol (and others) have invested, managed and shared in the revenues under such contracts. A major stumbling block for most IOCs is that they cannot book reserves under this arrangement. Flexibility on this issue could open significant opportunity for them. Within Mexico, the MSCs have suffered legal challenge. The last Burgos MSC round did not attract any bids.
  5. Bilateral agreements. Mexico may exploit regional politics to attract investment from Latin American NOCs. Petrobras would be the obvious example, given its deep water capabilities. Although this may form part of a solution, it is questionable whether sufficient investment would be delivered through such agreements.

20 July 2007

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