Moody’s downgrades Pemex as company tries to assert independence

Petroleos Mexicanos’ (Pemex) global foreign currency and local currency ratings have been downgraded by Moody’s Investors Service to Baa1 from A3, two rungs above the minimum.

“Moody’s believes that Pemex’s credit metrics will deteriorate further in the short to medium term as oil prices remain depressed, production continues to drop, taxes remain high, and the company’s capex needs are financed with debt,” said Nymia Almeida, vice-president, senior credit officer, at Moody’s.

In response, Pemex reiterated that the tools it has gained through energy reform make it possible for the company to continue to improve its capital structure.

During the last 3 years, the company has increased debt to fund large outflows for taxes, duties, and capital spending, without achieving sustained increases in production or operating efficiencies. Even when oil prices were at peak levels in 2014, cash flow from operating activities of $9.1 billion fell well-short of covering $15.1 billion in capital spending outlays, Moody’s explains.

In addition, since the sharp decline in oil prices that began in late 2014, Pemex’s operating expenses have been resilient, with negative effect on credit metrics.

Operational impacts

Pemex’s ratings consider challenges related to production, which has been falling gradually in the last several years due to the company’s limited ability to invest, Moody’s explains.

During the remainder of 2015 and in 2016, Moody’s estimates that Pemex’s production will decline 6% and 3%, respectively, as a consequence of many factors, including limited ability to invest in exploration and production given lower cash generation derived from lower oil prices but also high duties and taxes.

The pressure on the company to increase capex to boost production could decline in 2016 and probably in 2017 as well if the process to farmout existing production contracts accelerates and the company’s partners take a significant share of investments in the oil fields instead of Pemex.

The company may also choose to sell some nonstrategic assets or use Fibra E—master limited partnership-type of financial instruments—to raise capital to fund capex. However, most of these funding alternatives have been and will continue to be difficult to execute under a relatively new energy law.

The ratings also reflect the company’s sizable proved hydrocarbon reserves, which in 2014 amounted to about 12.38 billion boe, equivalent to 10.1 years of life; its oil production averaging 2.429 million b/d in 2014; its dominant role and integrated operations in the energy industry in Mexico; and its position as a leading crude exporter to the US. However, the ratings also factor in the company’s heavy tax burden and high financial leverage.

Close ties to government

Moody’s says its assumptions reflect the view that, despite recent changes derived from the energy reform, Pemex will remain closely linked to the Mexican government, which will continue to provide very high support given its status as state-owned company and its importance to the government’s budget, to the energy sector and to the country’s exports.

The government continues to exert outright influence on the company’s decisions. For instance, Pemex’s net financial balance as well as its maximum borrowing threshold must follow the government’s guidance and are approved by Congress on an annual basis.

In turn, government support to Pemex is exemplified by the 20 billion pesos and 10 billion pesos injected as equity contribution in 2014 and so far in 2015, respectively. The government is free to transfer cash to Pemex at any time provided that it generates income surplus.

Tax transfers to the government from Pemex declined materially in 2015 from 2014 and will remain low in 2016, based on Moody's oil prices assumptions. However, the rating agency believes that the company will continue to provide most of its operating cash to fund well-above 20% of the government's annual budget in the next 4 to 5 years.

In the longer term, as the share of new oil exploration and production projects increase of the total, Pemex’s tax burden should gradually decline, based on the new tax regime for the oil industry, as established in the new energy law. When this happens, Moody's would re-assess its assumptions for support and dependence under its joint-default analysis.

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