Via Wolf Street

President of Mexico not amused: “In three years there was no investment in exploration, no investment in drilling wells, and they rated Pemex very highly. Now that there is investment, they downgrade Pemex.”

By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.

After months of firing warning shots, one of the big three ratings agencies, Fitch Ratings, has downgraded to “junk” (BB+) about $80 billion of Pemex debt — much of it denominated in US dollars and held externally — and maintained its ‘negative’ rating outlook, meaning another downgrade is likely. The company is owned by Mexico.

The day before, Fitch downgraded Mexico’s sovereign debt to ‘BBB’  — only a couple of notches above junk.

Fitch’s downgrade of Pemex’s Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) from to lowest level of “investment grade” to “junk” (here’s our cheat sheet for corporate credit rating scales by S&P, Moody’s, and Fitch in plain English) forces some institutional investors to shed these bonds. It will raise Pemex’s costs of borrowing. And it could hurt Mexico’s already beleaguered economy. And also this week, Moody’s lowered its outlook for Pemex to negative from stable.

Fitch cited a host of reasons for its decision to downgrade Mexico’s sovereign debt, including “the increased risk to the sovereign’s public finances from Pemex’s deteriorating credit profile”, “ongoing weakness” in Mexico’s macroeconomic outlook, which is exacerbated by “external threats from trade tensions,” “some domestic policy uncertainty and ongoing fiscal constraints.”

The rating agency had already slashed Pemex’s rating by two notches in January. Moody’s did the same at about the same time. It was a double shot across the bow meant to spur Mexico’s populist President Andrés Manuel Lopez Obrador (AMLO) to reduce Pemex’s fiscal burden, pledge significantly more public funds to clean up the oil giant’s balance sheet, and stage a retreat from his nationalist energy strategy, which is popular among voters and loathed by investors, particularly overseas ones.

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In February, AMLO pledged to inject $3.9 billion into Pemex to bolster its finances and forestall a further credit downgrade. He also emphasized the cost savings Pemex stands to gain from his government’s multi-pronged offensive against the rampant oil theft that is draining the state-owned oil company of an estimated $3 billion a year. When that was deemed insufficient, the government bailed out Pemex with a further $5.7 billion of extra funds and tax savings in April. But according to Fitch, even that’s still not enough:

“The fiscal cost of that support to date represents 0.2% of GDP to the budget in capital injections and lower effective taxes, but in Fitch’s view, are not sufficient to provide a long-term solution or prevent continued deterioration in Pemex’s credit profile.

“Pemex’s tax bill (oil accounted for 2.3% of GDP in federal government revenue in 2018) exceeds its FCF (free cash flow), preventing it from investing sufficiently to maintain production and reserves. Fitch expects oil output to contract by 5% in 2019 and 2020.”

With long-term and short-term debt of $106 billion, of which roughly $85 billion is owned to bondholders, Pemex is the world’s most indebted oil company. If Moody’s or S&P also downgrades Pemex to junk – giving it two downgrades from investment-grade to junk — it would become the largest “fallen angel” in history, with a debt load twice as large as the current title holder, Petrobras.

This would trigger billions of dollars of forced selling by investors that are contractually bound to hold assets of investment grade quality, including many pension funds and sovereign wealth funds. And that would tighten the screws even further for both Pemex and Mexico.

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Given that Moody’s already rates Pemex’s debt just one notch above junk and S&P recently lowered its outlook for both Pemex and Mexico to negative from stable, warning that Mexico faces a one-in-three chance of being downgraded in the coming year, the odds of this occurring are high.

For it not to happen, Pemex would have to significantly improve its financial performance, Pemex’s tax burden would have to be significantly lightened (again), and AMLO would have to renege on a host of key policy pledges, including his government’s costly plan to upgrade a number of Pemex’s oil refineries as well as build a brand new one in his home state of Tabasco that is forecast to cost upwards of $8 billion. The plan is intended to reduce Mexico’s dependency on U.S. refineries for much of the finished gasoline it consumes.

For the moment, it seems unlikely that AMLO would backtrack on his plans, given just how important Pemex’s turnaround is to the AMLO government. Today, AMLO hit back at the rating agencies during his daily public address, accusing them of a lack of professionalism, of looking the other way as the last government plundered Pemex, and of using outdated methodologies that do not include variables such as corruption.

“In three years there was no investment in exploration, there was no investment in drilling wells in Pemex, and they rated Pemex very highly,” AMLO said “Now that there is investment, they downgrade Pemex. I assure you that corruption is no longer tolerated. So, we have these discrepancies.” Looks like he has his work cut out for him. By Don Quijones.

The former CEO of Pemex is on the hot seat. His lawyer suggests if the price is too high, he may be willing to take his friend, former president of Mexico, down with him. Read…  
“Largest Foreign Bribery Case in History” Claims New Scalp: Former Pemex CEO

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