Publish in Perspectives - Wednesday, June 8, 2016
Fittingly, Pemex’s new director-general José Antonio González Anaya is not an oilman but an American-trained economist with expertise in managing pension systems. (Photo: Pemex)
Why the Mexican oil giant is on slippery ground.
For decades following its nationalization in 1938, Petroleos Mexicanos (Pemex) was the symbol of Mexican state ownership and the country’s growing prowess as a producer of oil and gas. Pemex accounted for one-third of the tax revenues paid to the Mexican government.
In recent years, the tables have turned, forcing Mexico’s federal government to bail out Pemex, rather than rely on the oil giant for a significant share of its revenues. In mid-April, Mexico’s finance ministry announced a series of measures to improve Pemex’s finances, providing a $4.2 billion liquidity boost that includes a capital injection of 26.5 billion Mexican pesos ($1.5 billion) and a credit facility for a further 47 billion pesos. The support measures also include tax breaks that will allow Pemex to deduct more of its exploration and production costs.
Apart from the prospect of continued low prices for its oil and gas output, what are the other challenges facing Pemex? In what respects do these challenges resemble – and differ from – the pension-related problems confronting Petrobras, the state-owned energy giant of Brazil?
For years, Pemex’s $90 billion in unfunded pension liabilities has been a major headache, as life expectancy in Mexico has almost doubled over the past 70 years while pension benefits have remained broadly unchanged. “Instead of getting money from Pemex, the Mexican government has been asked to supply money to Pemex,” explains Kirk Sherr, president of Clearview Strategy Group, an international energy consultancy that has advised companies in Latin America. “What happened was that Pemex didn’t really think about the future; they forked over money to the government every year. But they were not setting aside any money for pension obligations, even though they were accruing them as liabilities.” These liabilities, which have doubled in the past five years, are by far the largest of any oil and gas company in the world. According to Bloomberg, they are almost four times as high as those of Exxon Mobil, which was second-largest at $24.4 billion, as of November 2015.
OUTPUT DROPS, PRICE FALLS
Meanwhile, Mexico’s oil output declined for 11 consecutive years, while crude prices have plummeted more 70 percent. In the fourth quarter of 2015, Pemex reported a loss of $9.3 billion, bringing its full-year loss to a record $32 billion. Output dropped to an average of 2.28 million barrels per day in the fourth quarter, a drop of 3.5 percent year-on-year, but sharply lower than the nearly 3.5 million barrels produced a little over a decade ago. Although output has constantly declined over the past decade, Pemex’s staffing has increased 4 percent to 153,000 workers during this period. Says Sherr: “Maybe they’re at the end of this [loop], but not yet. This is a negative feedback loop that is very damaging.”
Traditionally, notes Sherr, many Pemex jobs have been “sinecure positions.” Firings or downsizing were rare, and the job was not tied to individual performance. “No one’s job was tied to performance [of Pemex] as a whole, so the whole thing kept getting bigger and bigger. So they have these tremendous pension obligations, and they are trying to downsize.”
Last November, Pemex agreed with its powerful oil workers’ union to overhaul the pension program. In December, the company announced an estimated reduction on its pension liabilities of approximately $11 billion, which the government is expected to match. Near the end of 2015, the company reached an agreement to change its pension plan into a “defined contribution” from a “defined benefits” plan, and increased the retirement age for employees who have been with the company for fewer than 15 years to 60 years of age, and 30 years of service from the previous 55 years of age and 25 years of service. The government also injected about $2.9 billion in the form of non-tradable notes maturing in 2050.
Fittingly, Pemex’s new director-general José Antonio González Anaya is not an oilman but an American-trained economist with expertise in managing pension systems. A graduate of MIT, with a doctorate from Harvard, González Anaya was formerly a World Bank economist and professor at Stanford University’s Center for the Analysis of Development. In Mexico, he previously served as director-general of the Mexican Social Security Institute. “He is an economist who has made his bones in pension reform,” explains Sherr, who is also an adjunct professor of energy, security and technology development at Georgetown. “The fact that one of the top oil and gas companies in the world is now being run by a pension specialist tells you where the government is focused. Arguably they are not really focused on making Pemex a better company, per se; they are, in the near term, focused on making sure that they get the best pension negotiations possible.”
Monica de Bolle, non-resident fellow at the Peterson Institute for International Economics in Washington, D.C., agrees. “It is not surprising that Pemex is having these problems. Even if oil prices had not dropped the way they did, output in Mexico has been falling for more than a decade. Inevitably, there was going to be a point where Pemex was no longer the main source of revenues for Mexico but a financial drag. This situation has been pushed forward because of what’s been happening to oil prices.”
Despite the initiatives to lessen its pension obligations, de Bolle argues: “The future of Pemex looks quite bleak. Even if oil prices reverse course at some point, you’re still faced with this problem of oilfields that are basically depleted. With the deep-seawater stuff [in Mexico], like the pre-salt [offshore deposits] in Brazil, it’s not at all clear how you actually extract that. In Brazil, they have extracted some of it but it can be very costly; the breakeven prices vary widely depending on a number of technical and geological factors. It’s no wonder that Mexico has shifted gears for many years, and tried to advance other things with respect to its economy. It has tried to be a more open economy and diversify its manufacturing sector. It has done a number of other things to stay at least a bit away from oil dependency.”
Meanwhile, notes Sherr, Pemex is not only not contributing money to the government, it also continues to lack the funds it needs to slow the pace of its declining output. He explains: “The government is [now] saying we’ll cover the pension obligations, but you’ve got to slash your budget. And that includes both people and investments. But production is already declining because the fields are aging, and the big rounds [of auctions] have not yet resulted in new increased production from private investment.” This is now permitted under the recent energy reforms of the government of President Enrique Peña Nieto. “So less money is coming in. Less money is being invested in new production. The outlook for the next year is lower production, which means less money coming in, even at higher price levels for oil.”
“Because they [Pemex] have let the problem grow to such an enormous size, I can just imagine how complicated the discussions are internally,” adds Sherr. “There are a variety of ways you can cut. You can cut wholesale across different divisions, or you can do little cuts consistently. No matter what you do, though, you are going to piss people off. And when you do that, you have to have money in the bank. Typically, people will get a check as they go out the door and they are going to have money coming [to them] regularly. And if you miss a couple of payments in Latin America, people go talk to someone in the press, and they tell them that the Pemex pension [reform is failing]. Then they are dead in the water [because of the bad publicity].”
Why were the ramifications of Pemex’s ballooning pension obligations ignored so long? On the one hand, notes Sherr, it’s because oil and gas specialists are trained to focus not on the financial complexities of pension systems, but on the challenges of energy exploration and production. He explains: “This is one of the key stories that was reported and then glossed over because it is not really relevant to oil and gas. The pension story would fall on the side of labor law and social security issues.”
Another factor that may have discouraged attention to this complex issue is widespread financial illiteracy in Latin America. Olivia Mitchell, Wharton professor of business economics and public policy, and a former commissioner of the Chilean Pension Reform Commission, notes that her own research shows that “most Chileans had no idea how much they paid in commissions, how their money was invested, or how their benefits would be determined at retirement. Only one-fifth of the participants had the faintest idea about how much money they held in their accounts (even within plus or minus 20 percent).” Mitchell, who is also executive director of the Pension Research Council, adds that “financial illiteracy is a big problem, and not one confined to Chile. Yet the nation’s failure to educate its citizenry about how their pensions work and their role in retirement security is central to why three-quarters of the population [of Chile] now feels that a major overhaul is required.”
COMPARISONS WITH PETROBRAS
In significant ways, the pension crisis at Pemex runs parallel to that at Petrobras, the Brazilian energy giant, whose pension fund, known as Petros, lost more than 6 billion reals ($1.9 billion) in 2014, more than twice the 2.4 billion reals it lost in 2013. Founded in 1970, Petros is Brazil’s second biggest pension fund, with more than 72 billion reals under management in 2013, including investments in oil and telecommunications companies and the Belo Monte hydroelectric dam in Brazil’s Amazon.
“The two countries [Mexico and Brazil] are facing the same challenge,” says de Bolle. “They’ve gone through the demographic boom and are both going through the phase when the population is aging. The dependency ratios are rising. In both countries, the pension system is way overburdened. How do you resolve that? You need to do tough reforms. You have to think seriously about raising retirement age — changing the payment benefit structure. It’s a very tough nut to crack. Both countries are facing these issues in the short-to-medium term. It’s no longer an issue that you can ignore because it’s 20 years out. To me, it’s no wonder that they [both] have somebody heading the oil company who understands pensions and how they work.”
All these Latin American oil companies follow the same basic trajectory. As Sherr explains: “They discover oil. Then the oil company becomes the national symbol, identifiable with the country in so many ways. And, of course, shady deals go on in these companies. In the case of Petrobras, it has always been at the core of corruption. Just as in Pemex. The difference, which sets Petrobras apart now, is the sheer scale of corruption. They also face similar legal constraints. For example, Pemex has to have [an ownership] stake in all its projects. So does Petrobras. That puts a huge burden on these companies. And in a world where oil prices are falling, these companies look very similar in terms of the challenges that they face.”
De Bolle agrees, but adds, “There are several things that help Mexico. Certainly the proximity to the U.S. is a huge one. That makes a very big difference. The other thing is that Mexico, for a very long time now, has had an agenda of trade openness that sets it apart from the rest. Mexico began opening its economy with NAFTA back in the 1990s, when the rest of the region – even Chile, Colombia and Peru — were completely oblivious to the need to open their economies. Of all the countries in Latin America, Mexico is the one economy you can say is globally integrated into value chains and has a manufacturing sector that is part of those global chains. The effort that Mexico has made in striking and negotiating free-trade agreements all over the world really sets them apart.”
The positive impact of Mexico’s recent openness to global trade and investment will soon be felt on the pipeline, power and downstream side. This April, the Mexican government deregulated, almost a year earlier than first anticipated, the import of refined products into Mexico, enabling private investors to enter the market and operate gas stations. On the other hand, explains Sherr: “Longer term, it’s not clear yet where Pemex ends up in all this. Like Petrobras, it will take years to climb out from under these pension and other obligations. And in the meantime, a lot of good opportunities will be missed because they will have gone to other companies. Or [Pemex] will have had to partner with those other companies to make [those opportunities] viable.”
There is already better news for Mexico on the midstream (the pipeline) side. On April 1, Mexico conducted its first power auction, awarding 1,720 megawatts of wind and solar energy. A total of seven wind and solar organizations were awarded electricity contracts and clean energy certificates. The outcome of the auction is expected to help the government meet its long-range goal of producing 35 percent of its energy from clean sources by 2024. Winning bids came from such European firms as Spain’s Alten Renewable Energy and Italy’s Enel Green Power, which expects to invest $1 billion in the construction of three solar plants in Mexico.
In the short term, “until the uncertainty around the U.S. electoral process is finally over, there will be a little bit of constraint on investment [into Mexico’s energy sector],” Sherr argues. “Once that is cleared up, North America is well positioned economically to aggregate the benefits of Canada, the U.S. and Mexico with this energy reform. I think the Mexican economy will be very dynamic and you’ll be able to see some of the secondary effects of the reform. It is much later than President Peña Nieto probably would have hoped; the changes will come just around the time he is leaving office.”
Republished with permission from http://www.knowledge.wharton.upenn.edu -- the online research and business analysis journal of the Wharton School of the University of Pennsylvania.
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