Pemex May Be Turning From Gusher To Black Hole

Mexico's oil giant forks over so much money to the state that it's deeply in debt, and a price drop could set off a crisis

World oil prices are at near-record highs, and Mexico is pumping and exporting more crude than ever before. The country is the world's seventh-largest oil producer and one of the top three suppliers to the U.S., up there with Canada and Saudi Arabia. Yet state oil monopoly Petróleos Mexicanos (Pemex), a giant with $55.9 billion in revenue, is hardly thriving. Indeed, in recent years the company has only been able to make ends meet through massive borrowing, so that it now owes a staggering $42.5 billion, including $24 billion in off-balance-sheet debt. Why? Because Pemex is the Mexican government's cash cow. The state-run company pays out over 60% of its revenue in royalties and taxes, and those funds pay for a third of the federal government's budget. If oil prices drop or there are no major new discoveries of crude, that could spell big trouble for Pemex -- and Mexico's finances.

Pemex' mounting debt has international rating agencies worried. They don't believe the company will default on its obligations, which are considered quasi-sovereign debt and are implicitly guaranteed by the Mexican government. But Pemex' debt could begin to hamper its access to international capital markets unless the government finds other sources of tax revenue to meet its budget. "Fitch remains concerned about Pemex' significant debt level and its ability to reduce borrowing absent material fiscal reform," Fitch Ratings said in a Nov. 24 report. Officials from Pemex and from the Finance Ministry were unavailable to comment for this story.

The question for Pemex, and for Mexico, is what will happen if oil prices head south -- as many analysts predict they will next year. After all, Mexico's foreign-debt crisis in the early 1980s was sparked, in part, by a drop in crude prices. And Pemex' total debt load is four times that of Exxon Mobil Corp.'s (XOM ) -- a company many times its size -- and one of the highest for any oil producer worldwide. To compound the problem, production from Mexico's biggest oil field has peaked. The shallow-water Cantarell field in the Gulf of Mexico still provides 62% of Mexico's overall crude output, but by 2006 production will begin falling by as much as 14% a year, Pe- mex says.

Mexico is preparing to tap some new, smaller fields, but they will not fill the expected gap in production. "If we continue accumulating debt and crippling Pemex' ability to function as a normal oil company, we're looking at a time bomb that could have serious financial consequences for the country in less than two years," warns Francisco Rojas, a congressman who ran Pemex from 1987 to 1994.

For now, Pemex' cherished investment-grade rating is not in jeopardy. That might seem surprising considering the company is awash in red ink. Although Pemex consistently logs pretax profits, it has posted a net loss in each of the past five years because of its heavy tax burden. In 2003 it registered a $3.6 billion loss. Fitch Ratings Latin America energy analyst Jason T. Todd figures that by mid-2005, Pemex will have negative equity -- that its liabilities will exceed its assets. "Negative equity doesn't violate any borrowing covenants, but it raises concerns for us as to how the government intends to run this business," says Todd.


With the federal government draining its coffers, Pemex doesn't have enough money to invest in serious exploration. So while Mexico's oil production has risen 17.2% since 1999, to 3.4 million barrels a day, proven reserves have plunged by nearly 50%, to 16 billion bbl., over the same period.

In November, Pemex announced the discovery of possible reserves that may total 200 million bbl. of oil in the deep waters of the Gulf of Mexico. Yet independent oil analysts point out that extensive seismic studies and test wells will be needed to confirm the area's true potential, and Pemex has neither the financial resources nor the technical expertise to carry out those follow-ups on its own. Mexico, which nationalized its oil industry in 1938, is the only major Latin American country that doesn't allow foreign oil majors to participate in oil exploration and production.

That leaves Pemex with few options but to raise money for investment in the debt markets. It does so through bond offerings, plus off-balance-sheet project financing schemes known as pidiregas. In the past five years, Pemex has taken on some $24 billion in pidiregas, which are often financing packages offered by contractors that must be paid back when projects are completed.


Talk of privatizing Pemex -- one sure way to put it on a firmer financial footing -- remains politically taboo in Mexico. So President Vicente Fox has instead focused on improving the way the oil monopoly is run and making sure it has the financial resources it needs to keep pumping oil. But the opposition-dominated Congress has foiled him at every turn. Raúl Muñoz Leos, the former DuPont (DD ) executive Fox appointed to run Pemex, quit on Nov. 1 after less than four years on the job, frustrated that his efforts to shake up the bloated, inefficient oil monopoly had been thwarted. And last month the senate quashed a bill that would have reduced the royalties Pemex must pay the government on future oil finds. As a last resort the government recently floated the idea of allowing Pemex to raise money by issuing shares that could be purchased only by Mexican citizens and local pension funds. But that proposal got a chilly reception from Congress, too.

Critics charge that high oil prices have bred complacency among Mexican politicians. Mexico will reap $22 billion in revenue from oil exports this year -- a 24% increase over 2003. That has allowed the government to put aside money for regional infrastructure projects and sock away millions into a rainy-day fund that can be tapped when oil prices are low. Nevertheless, in a Nov. 22 report Fitch noted that Mexico has used its oil bounty less productively than Russia, which is running a fiscal surplus even as it spends many of its petrodollars to pay down the country's debt.

That's a huge wasted opportunity. If Mexico doesn't open its oil industry to private investment, the government will have to come up with $70 billion to $100 billion in investment capital for Pemex in the coming decade to maintain production at current levels. "There's no way Mexico can tap its oil reserves with public money -- the government doesn't have enough resources, and it never will," says Luis Téllez, a former Energy Minister who now heads the Mexico office of Carlyle Group, a Washington private-equity outfit. If the price of oil does drop, along with Mexico's production, the country's nearsighted politicians will have a lot to answer for.

By Geri Smith in Mexico City

    Before it's here, it's on the Bloomberg Terminal.