Wealthy Nations Daily Update - Mexico and Pemex

As the oil glut continues to weigh heavy on black gold dependent economies, countries such as Mexico have employed spending cuts as a way to shield themselves from the ongoing pressures. A couple of weeks ago, the country’s Finance Ministry announced it will be slashing spending by an additional MXN 175bn ($10bn) in 2017, this is on top of the ~$7.5bn worth of cuts this year; or 0.7% of GDP. The spending cuts in 2017 assume crude will be priced at $35pb, this is above the pessimistic $25pb estimated for 2016, crude is currently ~$44pb; however unlike other oil producing economies, the government has the safety net of the ~$50pb revenue hedge this year.

According to sources, in recent years the government has depended on revenues from state-owned oil giant, Petroleos Mexicanos (Pemex) for roughly one third of the federal budget. As such, the country’s Finance Ministry announce yesterday that it will grant Pemex support totalling MXN 73.5bn ($4.2bn). This liquidity boost is said to be made up of ~$1.5bn in capital and a credit facility worth ~$2.7bn; allowing the pension and retirement liabilities to be paid off this year. In return the government will require the oil-monopoly to reduce its debts and liabilities in-line. Last month the company had begun taking such steps announcing it had secured credit lines with three of the the country’s development banks to facilitate ~85% of debt owed to suppliers, and provide additional liquidity.

We are exposed to Pemex, via the 6.625% issue maturing in 2035, since the announcement, the bond has rallied a couple points, and is currently trading at a spread of ~455bps over Treasuries, or a yield of 6.72%. The bond has gained over 17 points since the lows in January and continues to remain attractive. Our proprietary Relative Value Model (RVM) calculates that, on average, BBB+ rated bonds with a ~10.5 year duration trade at roughly 220bps over. This suggests that the bond will need to tighten ~235bps to reach fair value, or more simply put, will have to rally a further 28 points to match its peers.

We look to Sunday, where both OPEC and non-OPEC members gather in Doha to discuss the possibility of an oil production freeze. With Iran's return to the market and obvious resistance to curbing production, we suspect that no solid “deal” will be reached. As markets continue to ‘buy the rumour, sell the fact’, we expect that some form of an agreement will more than likely be overblown; as market psychology dictates.



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