Looking back on 2015 Mexico’s government risks being better remembered for the “El Chapo fiasco” in which the drug lord, Joaquín “El Chapo” Guzmán, escaped from, Altiplano, the ‘maximum security prison’, in July ‘15 and remained on the run until January ‘16. Adding to the humiliation, only following an interview with Sean Penn for Rolling Stone magazine did the authorities finally track him down and arrest him. The media love this sort of story and it has pretty much eclipsed anything positive the government might have done.
But given the latest leg down in oil prices the Mexican government should get some credit for its oil hedging strategy. The government protected its 2015 budget forecast based off USD79 per barrel with oil put options set at an average price of USD76 per barrel for the Mexican oil basket; this proved extremely advantageous as the actual price for the Mexican basket of oil was USD44 per barrel. (The Mexican crude mix, Mezcla Mexicana, trades around USD10 below the Brent crude price.) The government also put a hedge in place for 2016 at a strike price of USD49 to protect the budget forecast which assumes an oil price around this level, assuming Mexico adheres to the production assumptions and makes the planned expenditure cuts. Admittedly, the put options cost the government USD1.09bn versus USD773m last year but the profits from these hedges have been huge; estimates put the payout at USD6.4bn for the 2015. The strategy could also pay off in 2016; earlier this month the Mexican crude basket traded below USD20 per barrel at the lows.
PEMEX, Mexico’s dominant oil company, is 100% owned by the government, but does not directly benefit from this hedging strategy, but by its quasi-sovereign nature is backed by the government. Unquestionably, PEMEX’s credit metrics will continue to be under pressure, and it is under review for a possible downgrade, but as Moody’s note (30 November 2015) “Our assumptions reflect the view that, despite recent changes derived from the energy reform, PEMEX will remain closely linked to the government of Mexico, 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.”
They also note “We think extraordinary support from the sovereign is unlikely to be called upon as long as the company has access to funding through bond markets.” On Wednesday Miguel Messmacher, the Deputy Finance Minister, stated “We will be evaluating the possibility of allowing some change in PEMEX’s balance sheet or the possibility of some contribution in capital terms.” Following this PEMEX was able to access the market with an USD5bn debt issue of three, five and ten year notes that was 3.5x oversubscribed. Given Mexico’s credit strengths, Moody’s envisage any support will be manageable at Mexico’s A3 (stable) rating “under all but the most extreme cases”; they note that Mexico debt to GDP levels at ~35% are lower than some other similarly rated sovereigns. If the government were to take on all of PEMEX’s debt they estimate Mexico’s debt to GDP would increase by ~10%.
PEMEX 6.625% 2035 USD bond is trading at a yield of 7.9% (~4.3 credit notches cheap on our models) versus the USD Mexico 4.6% 2046 issue yield of 5.34%; we consider this is a lot of extra compensation for any additional risk. In a deleveraging, low inflation world, it is the debtors that will suffer the most, regardless of whether that country is a net energy importer or exporter. We expect the current deleveraging cycle to lead to further downgrades and in the case of the most indebted nations, eventual default.