Wealthy Nations Daily Update - Mexico

Encouragingly, the second phase of the first round of the Mexican Government’s oil block auctions attracted more interest than the initial phase. Bids were made for 3 of the 5 blocks with estimates that these should attract USD 3.1bn in investment over the 25 year deal life. The step up in interest partly reflects more interesting geology, better legal and fiscal terms, and assets for extraction rather than exploration. But it also reflects improvements in the bidding process with the minimum threshold for any bid being revealed two weeks ahead of the bid dates and a USD 2.5m bid security guarantee for all contracts rather than each block . The third phase is due to take place in December this year with 25 onshore blocks up for auction which are expected to attract interest from local players. Thereafter, the deep-water fields are expected to be auctioned which are expected to generate a good level of interest from the global majors.

Mexico’s energy sector reform aims to boost foreign direct investment in the oil and gas sector and to boost Mexico’s declining production profile. Currently, the government budget projects that oil production will be 2.262 mbpd for 2015, falling to 2.247 mbpd in 2016, with only an increase of 0.1 percent expected in 2017. This industry transformation means Pemex, the government owned entity, no longer has a monopoly, although it remains the dominant player having retained 83 percent of Mexico’s probable reserves and 21 percent of its prospective reserves. Pemex remains 100 percent government owned but it is being given more autonomy and flexibility and is expected to be run more like a private sector company.

In September, Luis Videgaray, the Finance Minister, announced the draft budget estimates which aim for a path of fiscal consolidation despite lower oil prices. Mexico is forecast to grow in a range of 2.6 to 3.6 percent down from earlier estimates of 3.3 to 4.3 percent. The budget aims to cut the fiscal deficit from 3.5 percent of GDP to 3 percent in 2016 and the primary deficit to 0.5 percent from 1.3 percent. Given the weakness in the oil price and declining production this means significant spending cuts. The budget assumes a price of USD 50 per barrel for the Mexican blend for this year and next. The oil revenue estimates are reasonable as Mexico has hedged its 2016 production at USD49 per barrel next year using put options. The remaining USD1 per barrel is covered by a MXN 3.7bn balance within the oil stabilisation fund.

Based on these assumptions, oil revenues are expected to decline as a proportion of total revenues to 29 percent in 2015 and 20 percent in 2016. Total revenues are expected to drop to 21.5 percent of GDP in 2016 from 22.2 percent in 2015. Expenditures are expected to fall to 24.5 percent of GDP from 25.7 percent this year. On the positive side, there has been a pick-up in non-oil related revenues from improved tax collection. The government is looking for some recovery in the Mexican peso in its projections forecasting an average exchange rate of 15.9 to the US dollar for 2016 against the current exchange rate of 16.4256.

The budget is encouraging as, despite the more difficult operating environment, the government is showing itself determined to make the necessary changes to maintain a good level of fiscal discipline. This, combined with the structural reform agenda, which extends beyond just the hydrocarbon sector, continues to support Mexico’s credit rating.