Juan Pablo Newman knows firsthand how lower oil prices are forcing belt-tightening at Pemex.

When he took over as the chief financial officer at the Mexican state oil company in January, he became the first employee to join under a new pension scheme that enrolls employees into individual retirement accounts instead of defined benefit plans. The intent: to help ease the company’s liabilities.

“All of us new employees are subject to a different regimen — this ensures that [pension obligations] won’t continue to grow,” Newman tells LatinFinance.  

Suffering from lower oil prices, declining production and a sharp cut in its budget, Pemex, long a cash cow for the Mexican government, is working double-time to get its financial house in order.  

Two years after Mexico passed its sweeping energy reform that took away Pemex’s oil monopoly, the company is working to chart a path forward to revitalize its money-losing refineries and reverse an 11-year drop in oil production.

The Mexican government clearly wants a smaller and more efficient Pemex. And the backdrop of low oil prices provides the opportunity to implement some harsh changes.  

“When times are tough, you can extract efficiencies,” says Joe Kogan, director and co-head of Latin American strategy at Scotiabank.

The pension changes were one of several concessions that a previous Pemex administration negotiated with the company’s powerful union last year. The average worker eligible for a traditional pension will have to put in an extra five years to retire — the retirement age rose to 60 from 55 and will reach 65 in 2021 — while the minimum years of service to be eligible for retirement also rose. The federal government estimated total savings from the union deal at 184 billion pesos ($9.98 billion).

The deal marked the biggest concession from the union since Pemex was founded in 1938. And it gave both the company and the government some breathing room. Pemex, the world’s ninth-biggest oil producer, has $90 billion in unfunded pension liabilities, some of which will be absorbed by the government. In return, the Mexican government agreed to match the savings from the deal, disbursing an additional 184 billion pesos to Pemex in August.

Hoping to ignite a turnaround, new Pemex CEO José Antonio González Anaya plans to attract international oil companies as partners. Meanwhile, Pemex has closed two sale and leaseback agreements with private equity funds as it tries to raise money and pay down debt, and is looking to do more. The company also has plans to put assets up for sale. And although Pemex has completed its financing program for 2016, Newman says, the company would consider tapping the markets to prefund for next year.

Pemex’s second-quarter earnings showed the sense of urgency: The company lost $4.4 billion, a 62% increase from the losses it recorded in the period a year earlier.

Under González Anaya, the company is sharply focused on improving the bottom line, Newman says. “What Pemex has to work on, and what we’ve been working on, is improving our efficiencies,” he says.

Beyond the tug-of-war

Newman has deep ties to Mexico’s finance ministry, as does González Anaya, who was appointed to lead Pemex in February. Both executives previously worked directly for the ministry. 

Their appointments are seen as fostering a more open and friendly dialogue between the two state entities, which have long been engaged in a sort of tug-of-war. Pemex generates cash, some of which ends up padding the federal budget, which in turn determines how much the company can spend each year.

To project a united front, Mexican Finance Minister Luis Videgaray and González Anaya this year traveled together to meet investors. The main topic in those conversations was Pemex’s announced budget adjustments. The company trimmed its 2016 budget by 20%.

There was also an underlying message: the government supports Pemex. It was the first time in decades that directors from the two state entities embarked on a roadshow together. “This in itself is an important image,” Newman says.

Oil accounts for one-fifth of the Mexican government’s annual revenue. But as recently as 2012, Pemex and oil-related income provided for up to a third of the federal budget. 

In a pinch, the government can release more funds to Pemex. That safety cushion has been on display in 2016. Lower oil prices forced Pemex to slash $5.5 billion from its annual budget in February. But in April, the finance ministry provided $4.2 billion so the firm could pay overdue bills to service providers. 

George Baker, who has followed Pemex for more than two decades as an independent analyst and consultant, compares budget tightening at Pemex to tough love for an addict. For now, he says, the company is right to focus on costs. “You don’t fix anything at Pemex by increasing production,” says the Houston-based editor of Mexico Energy Intelligence. 

Longer-term, however, Pemex will need to reverse its declining oil output. 

Pemex executives are hunting for strategic partners to help the company share production expenses. So far, oil majors have been slow to show interest.

One concern may be the company’s safety record. Thirty-two workers died in April at a Pemex petrochemical joint venture in southeastern Mexico. It was the company’s deadliest incident since an explosion rocked Pemex’s Mexico City office tower in 2013. Last year, two workers from a service provider died on a drilling platform and another seven Pemex workers lost their lives in an explosion on a production platform, in the Campeche basin.

International oil companies consider a single death in any fiscal year to be a major catastrophe.

Joy Gallup, a partner in the Latin America and corporate practices at law firm Paul Hastings, says some of her clients have expressed interest in partnering with Pemex. However, a few are worried about the budget constraints. “People are still holding back,” she says.

While Pemex hunts for partners, the government is auctioning off oil blocks, giving the majors the option of going into Mexico without Pemex. 

The biggest gauge of interest looms in December, when Mexico hopes to raise $44 billion via the auction of 10 deep-water blocks in the Gulf of Mexico. More than a dozen oil companies have requested information on the blocks, including Pemex, as well as Statoil, Chevron and Exxon. 

“The worst thing that could possibly happen is if nobody bids,” says Baker, who warns high royalties could be a turnoff for the majors.

Debt appeal

Despite the challenges, investors remain attracted to Pemex bonds. The shows of government support for the company have not gone unnoticed. And Pemex bonds offer a premium of nearly 200 basis points over Mexican sovereign debt.

Ray Zucaro, chief investment officer at RVX Asset Management in Miami, thought that the Pemex bashing had gone too far in April, when bond prices fell, and his fund swooped in to buy some bonds. 

The question on investors’ minds, Zucaro says, is: How far is the government willing to go to protect the company? As a quasi-sovereign, Pemex has always been seen as too big to fail. 

“At the end of the day, Pemex has negative financials because their only shareholder taxes the wazoo out of them,” he says. “But in no scenario do we envision Mexico allowing Pemex to have any sort of payment disruption.”

Investors are embracing the efforts to clean house and lower operating costs at Pemex. But they also see a need for the company to secure new sources of capital, apart from debt markets.

Pemex’s efforts to farm out various oil and gas assets are finally gaining pace, notes Gregory Magnuson, senior corporate analyst for emerging markets debt at fund manager Neuberger Berman. Magnuson points to the sale and leaseback transactions as an example of ways the company can monetize its assets to fund future exploration and production expenditures.

Still, Magnuson says, the efforts to diversify Pemex’s financing have been slow to materialize. “Whether the fault lies with the government or with the company, this has taken much longer than it should have.” LF

Additional reporting by Kevin Gray.