Mexican oil prices stay low as demand tanks, storage maxed out

Rather than providing a much needed jolt in oil prices, Sunday’s historic OPEC+ deal to lower global production by 9.7Mb/d has done little to help the price of the Mexican mix, which fell to US$14.17/barrel on April 17 from US$17.16 on April 13 – the day after the deal was announced.

The reason, according to various experts, is that with Pemex’s limited hydrocarbons storage capacity – and storage filling up worldwide, the state-owned oil company has no room to bargain, much less justify the reduced production cuts it “won” in the OPEC+ agreement.

John Padilla, managing director and partner at energy consultancy IPD Latin America, explained that the largest coordinated production cut in history “Sadly wasn’t enough.” 

“We're surviving an event that hasn't been seen in living memory,” he added, speaking at an online panel on oil prices and Mexico organized by the Wilson Center and local daily El Universal on Thursday, noting the disruption in demand is far too great and the reality of storage, particularly in Mexico makes the country vulnerable. 

He and others at the event cited the International Energy Agency’s (IEA) latest oil market report (available here) showing it expects to see oil demand tumble by 29Mb/d (million barrels per day) in April compared to a year ago.

“We're talking about a third of oil consumption in the world, in a period of about two months,” said Jeremy Martin, VP for energy and sustainability at hemispheric policy think tank Institute of the Americas. “It's shocking in a way that we cannot comprehend.”

The IEA report added that demand in 2Q20 should be 23.1Mb/d below the levels seen 12 months earlier, with only a gradual recovery expected in the second half of the year, adding that even if travel restrictions begin to lift in 2H20, “We expect that global oil demand in 2020 will fall by 9.3Mb/d versus 2019, erasing almost a decade of growth.” 

Lourdes Melgar, research affiliate at MIT’s Center for Collective Intelligence and non-resident fellow at the Baker Institute, noted how, given current demand, US energy authorities are expecting production to exceed storage capacity by 3.9Mb/d this year, more than twice the next highest level on record (1.9Mb/d in 1998). 

Under these conditions, Padilla said, “Refineries are producing more fuel oil than the market can absorb, and there's no storage [here in Mexico] either and that will cause problems with Pemex.” 

“The problem is that storage capacity is filling up all around the world,” added Melgar. “This crisis could last for several years. It's not clear when the reactivation of economies is going to occur.” 

Martin described the situation as “extremely worrisome” for countries like Mexico that not only have a dependence on oil sales for their annual budget but which are also coming off a recession, noting the near zero GDP growth seen in 2019. 

Adding to Mexico’s woes is the fact that the federal government is not enacting  countercyclical measures and supports for SMEs and large employers being seen in the rest of the world’s major economies.

OIL PRICES NOT GOING ANYWHERE FOR NOW

Martin also stressed how any prediction on oil prices beyond just the coming months would be presumptuous given that “We're still in the virus crisis… in the business of health issues,” but added that no one should expect any oil price recovery in the short term.

“We're going to see how [the US] and other countries little by little reopen their economies what impact that has, but for sure in April and in May these low prices are going to continue. Let’s hope in June, July we can see a little recovery,” Martin said on the panel.

PEMEX REALITY CHECK

Pemex and the government have gained a small respite with the oil hedge purchased for 2020 at US$49, with the company’s CEO saying earlier this week it could save Pemex 7.5bn pesos (US$315mn). 

Melgar, however noted that depressed oil prices going into 2021 would certainly spell trouble for Pemex.

She added that there is little justification during the COVID-19 crisis to intensify E&P and refining at Pemex as has been the objective of President Andrés Manuel López Obrador (AMLO), much less the continued construction of the US$8bn Dos Bocas refinery project.

“It's almost obscene to be putting money into a refinery right now, when money is urgently needed first of all in the health sector… It's urgent to put money there,” said Melgar. “It doesn't make much sense to put money into Dos Bocas when Pemex hasn't profitably produced or refined, and there's a huge surplus of gasoline on the market.” 

Looking at E&P, “No fields anywhere are profitable right now,” said Padilla, adding that Pemex has higher costs than most compounded by its roughly US$105bn in debt (about the size of Argentina’s entire foreign debt, he added). 

“Even with the new DUC [shared profit rights] moving from 58% to 54%… [Pemex] still requires [a per barrel price of] US$78 to make money,” said Padilla, noting a small price increase would matter little at this point.

“The conversation in the markets has changed radically, because for a long time they weren’t worried about Pemex because it had its ‘daddy’, which was the finance ministry,” said Padilla. “And as the government had its debt as a percentage of GDP at around 40%, everyone said, ‘Well, they have lots of space, a lot of latitude with that level of debt.”

“The truth is that this is going to change this year, and quickly,” said Padilla. 

The reality check is coming now in the form of the ratings downgrades being seen for the sovereign, Pemex and CFE from ratings agencies, the latest being Fitch’s downgrades of Pemex and CFE on Friday.

“So everyone now is basically waiting to see Moody’s, because things being how they are today, it’s hard to see an 'A3' rating stand,” said Padilla. 

“This space that Mexico has had is rapidly disappearing… this is a domino effect and it’s going to create some complicated situations,” he added.

Martin noted that with the downgrades, “The agencies are underscoring that the Pemex model is broken, it doesn’t work. In a word, it’s bad…it’s a failed model,” adding that even though it clearly makes no economic sense, the promises from AMLO to resurrect Pemex and make it a lever for development in the country make it a political obligation to which he still seems fully committed. 

For Mexico’s recovery, it will need to ramp up the diversification of its economy, not become more reliant on oil, noted Padilla.

"If we lower the amount of dependence on oil returns from 40% to 17% [that’s great], but the truth is that we need to diversify the economy, that will be the best remedy,” said Padilla. 

That said, Martin pointed out that two key areas that Mexico has diversified into – remittances and tourism – are also bound to suffer significant hits.

Also worrisome, he added, was that it remains unclear the full nature of the agreement made with US President Trump in the OPEC+ negotiations to win the reduced production cut to 100,000b/d.

“Mexico owes something,” he said. “Where does this fit in? Where is this going to come up?”

Pictured: Construction at Dos Bocas in March.