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CROSS-SECTOR
ISSUER IN-DEPTH2 December 2016
RATINGS
PEMEXIssuer Rating Baa3
Baseline CreditAssessment
b3
NSR Senior Unsecured Aa3.mx
NSR Commercial Paper MX-1
Outlook Negative
Government of MexicoIssuer Rating A3
NSR Issuer Rating Aaa.mx
Outlook Negative
Analyst Contacts
Nymia Almeida 52-55-1253-5707VP-Sr Credit [email protected]
Jaime Reusche 212-553-0358VP-Senior [email protected]
Marianna Waltz, CFA 55-11-3043-7309MD-Corporate [email protected]
Mauro Leos 212-553-1947VP-Sr Credit [email protected]
Steven Wood 212-553-0591MD-Corporate [email protected]
CLIENT SERVICES
Americas 1-212-553-1653
Asia Pacific 852-3551-3077
Japan 81-3-5408-4100
EMEA 44-20-7772-5454
Petroleos MexicanosFrequently Asked Questions about Credit Quality for PEMEXand Mexico
» Several things have happened since we downgraded PEMEX to Baa3 and changedour rating outlook to negative in March 2016. Mexico’s national oil companycommitted to reducing its capital investments and operating expenses of MXN100billion (USD5 billion), equivalent to nearly 21% of its annual capital and operatingspending for 2016; announced auctions for farmouts; closed a $1.14 billion asset sale;and released a new business plan focused on profitability and returns on investment tohelp control debt. Meanwhile, PEMEX’s relationship with the government of Mexico hasimproved enough to signal the government’s full support for PEMEX’s goals.
» Any change in the North American Free Trade Agreement (NAFTA) would beunlikely to affect PEMEX’s credit quality directly, because crude and fuel are notpart of NAFTA. Many US refineries depend almost solely on Mexican crude, and Mexicoimports more than 60% of its gasoline and diesel, most of it from the US. But even ifthe US restricted its purchase of Mexico’s oil, PEMEX would readily find other buyerselsewhere.
» Because the two issuers are closely linked, any rating action on the governmentof Mexico would prompt us to review PEMEX’s ratings, and vice versa, if notnecessarily take rating actions on either. We would revisit PEMEX’s standalone creditquality and assess the size of its external funding needs, assuming it had no access tothe capital markets. We would also revisit the Mexican government’s ability to supportPEMEX in case of need—something that would depend mainly on how much moneyPEMEX needed and on the government’s capacity to help.
» We estimate that we would be in a position to review the Mexican government’srating in the second half of 2017, and if possible, we would consider reviewingPEMEX’s rating simultaneously, given their symbiotic finances. We could alsoreview PEMEX’s ratings before or after we review Mexico’s ratings, however, if a relevantevent prompted a rating committee.
MOODY'S INVESTORS SERVICE CROSS-SECTOR
This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page onwww.moodys.com for the most updated credit rating action information and rating history.
2 2 December 2016 Petroleos Mexicanos: Frequently Asked Questions about Credit Quality for PEMEX and Mexico
Q. In your view, how has PEMEX’s credit quality changed over the course of 2016?Several things have happened since we downgraded PEMEX (Baa3 negative) and changed our rating outlook to negative in March2016. Mexico’s national oil company committed to reducing its capital investments and operating expenses of MXN100 billion,equivalent to nearly 21% of its annual capital and operating spending for 2016, which it contends it will achieve by the end of 2016.PEMEX announced auctions for farmouts —assignments of part of an oil/gas interest to a third party— in deepwater, shallow-waterand onshore oil projects between December 2016 and April 2017. PEMEX also closed its $1.14 billion sale of its 50% stake in a naturalgas pipeline, and released a business plan focused on generating higher operating profitability and returns on investment to help reduceits debt growth.
Meanwhile, PEMEX has also shown a commitment to improving its operating performance and financial situation over the course of2016, and its relationship with the government of Mexico (A3 negative) has improved significantly enough to signal the government’sfull support for PEMEX’s goals.
Although these positive events will help reduce PEMEX’s dependence on external funding and reduce the speed of the severedeterioration in its credit metrics, we cannot yet assume PEMEX will succeed with its plans, which will require factors beyond its controlsuch as oil prices and how well Mexico’s oil and gas sector attracts outside investors. As of September 2016, PEMEX still had negative$12.1 billion in free cash generation, or operating cash after interest expenses and capital spending.
Our negative outlook on PEMEX’s Baa3 ratings reflect our expectation that its credit profile may still deteriorate more substantiallythan the weakening incorporated into its b3 baseline credit assessment (BCA) —our measure of a state-owned company’s standalonecredit risks without regard to government support. However, we could revise the outlook to stable if PEMEX manages to reverse thecurrent trend of significant increasing leverage and shows signs that it can improve its operating and financial profile in the mediumterm.
Q. How might the new US government affect PEMEX’s ratings?Any change in NAFTA —which President-elect Donald Trump has vowed to renegotiate or withdraw— would be unlikely to affectPEMEX’s credit quality directly, because crude and fuel are not part of the trade agreement. Moreover, both the US and Mexico benefitsignificantly from crude and fuel trade, with many US refineries built almost solely to process mostly Mexican crude. Mexico importsmore than 60% of the gasoline and diesel that it consumes, most of it from the US. But even if the US restricted its purchase ofMexico’s oil, PEMEX would readily find other buyers elsewhere, although discounts would be higher and the netbacks to the companylower.
For the oil industry in general, proposals by the incoming Trump administration to stimulate investment in the sector could havepositive spillover effects in Mexico, which only recently opened its oil industry to private and foreign investments in exploration andproduction, pipelines and refining and marketing. Pressures on the government’s fiscal balance, prompted by lower economic growth orhigher interest rates, could increase PEMEX’s tax expenses or dividend payments, however, which would strain its credit quality.
Even with a weak peso, PEMEX has limited foreign exchange risk, because 98% of its sales and 83% of its debt is denominated in USdollars or other hard currencies. Higher interest rates in the US would increase its debt burden, however.
Q. What if further risks emerge for the sovereign rating? What would that mean for the rating of PEMEX?Despite a slowing economy, Mexico’s government finances have had a favorable dynamic due to expenditure restraint and better-than-expected government tax revenue growth. If maintained, the favorable results on fiscal consolidation would support creditworthiness,given that fiscal concerns were a key element that led to the negative outlook on the sovereign’s rating. However, an adverseexternal environment suggests that economic growth is unlikely to accelerate in 2017, implying continued downside risks to themacroeconomic outlook. These divergent forces are still evolving and it is too early to determine whether the macroeconomic riskswould materialize to the point of derailing the government’s fiscal consolidation program.
Because the government of Mexico and PEMEX are closely linked, any rating action on the government of Mexico would promptus to review PEMEX’s ratings, and vice versa. But such a review would not necessarily lead to actions on ratings for PEMEX or the
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government of Mexico. In November 2015, for instance, we downgraded the ratings of PEMEX with no consequence on the ratings ofMexico.
Exhibit 1
Rating HistoryPEMEX and Government of Mexico
Source: Moody's Investors Service
PEMEX’s Baa3 ratings depend on its underlying b3 BCA and our assumptions about the government’s willingness and ability as thecompany’s owner to provide extraordinary support in a distressed situation.
Our analysis starts by first assessing PEMEX’s BCA and measuring the size of its external funding needs, assuming it had no accessto the capital markets. In recent years, PEMEX has directed almost all of its EBITDA to tax payments, forcing it to fund its capitaland interest expenses with external resources. Its ability to increase EBITDA and reduce capital spending further without significantlycompromising crude production or safety standards would reduce PEMEX’s external funding needs to levels lower than we anticipatedwhen we downgraded the company in March 2016. PEMEX in November 2016 released a new business plan suggesting it can generatehigher cash flow by increasing operating profitability and returns on investment, and actual cost savings and closing of farmoutagreements would offer evidence that its efforts are working.
Secondly, we would assess the Mexican government’s ability to support PEMEX in case of need—something that would depend mainlyon how much money PEMEX needed and on the government’s capacity to help. We estimate the likelihood and degree of governmentsupport based on the dependence and support levels, and a high degree of dependence yields strong credit links that increase default
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4 2 December 2016 Petroleos Mexicanos: Frequently Asked Questions about Credit Quality for PEMEX and Mexico
correlation and probability at times of stress. We base our assessment of support on historical explicit or implicit government support,legal guarantees, the government’s ownership stake, subsidies, transfers and other benefits from the sovereign entity. PEMEX’s ratingsincorporate our assumptions of both very high support and very high dependence.
Currently, PEMEX’s Baa3 rating incorporates 6 notches of uplift from its b3 BCA. We would change the number of notching uplifthigher or lower if either the credit risk of the company or its sponsor’s change. But that would mark just one factor among othersunderpinning our decision to keep, shrink or widen the notching between PEMEX’s BCA and its final rating.
Q. When do you next expect to review the ratings and outlooks of Mexico and PEMEX?We estimate that we would be in a position to review the Mexican government’s rating in the second half of 2017, and if possible, wewould consider reviewing PEMEX’s rating simultaneously, given their symbiotic finances. We could also review PEMEX’s ratings beforeor after we review Mexico’s ratings, however, if a relevant event prompted a rating committee.
Before we review Mexico’s ratings, we would prefer to confirm that its positive fiscal consolidation trends will be sustainable and thatthe government will continue to narrow the federal deficit enough to stabilize its debt ratios.
We would plan to review PEMEX’s ratings and outlook if we believed we had enough information to anticipate a sustained andsignificant reduction in external funding needs that would decrease its liquidity risk and reduce its dependence on government support.In the other direction, we would revisit PEMEX’s ratings and outlook if we saw increasing liquidity risks, a big further increase in itsfinancial leverage, a significant deterioration in its production, or a change in our assumptions about government support.
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Peer Group:
» Petroleo Brasileiro S.A. - PETROBRAS
» Ecopetrol S.A.
» YPF Sociedad Anonima
Methodologies Used
» Global Integrated Oil & Gas Industry
» Government-Related Issuers
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Moody's Related ResearchPEMEX
» Issuer Comment: PEMEX’s business plan shows commitment to improve operating and financial results but execution risk is high, 4November 2016
» Credit Opinion - PEMEX, 30 September 2016
» Sector Comment: Mexican Budget Cuts Are Credit Negative for PEMEX and Construction Companies, 12 September 2016
» Issuer Comment: Mexico Lightens PEMEX’s Pension Burden with $10 Billion Grant, a Credit Positive, 22 August 2016
» Company Profile: PEMEX, 25 July 2016
» Issuer Comment: PEMEX Gets Lift from Mexican Government’s $4.2 Billion Commitment, 18 April 2016
» ISSUER IN-DEPTH - FAQ on PEMEX’s Rating Review, 10 February 2016
Government of Mexico and Sovereigns
» Sovereigns – Global: 2017 Outlook – Negative Outlook As Low Growth, High Debt Limit Policy Options, 14 November 2016
» Issuer Comment: Budget’s Economic and Fiscal Targets In Line With Our Forecasts, But Implementation Risks Remain, 10 October2016
» Issuer Comment: Oil Hedge Program Underpins the 2017 Budget, 8 September 2016
» Credit Opinion - Government of Mexico, 31 August 2016
» ISSUER IN-DEPTH: Government of Mexico - External market volatility remains unsupportive for growth, posing continued policychallenges, 3 August 2016
Global Oil and Gas
» Global Oil and Natural Gas Industry – Global: Oil Prices Likely to Remain Range-Bound and Volatile in 2017, 30 November 2016
» Oil and Gas – Latin America: Reduced Cash Flow and Spending Will Keep Credit Quality Weak Through Mid-2017, 13 June 2016
» Sector-In-Depth - Sovereigns - Latin America: Reversal of Fortunes - Governments Face Growing Calls to Support State Oil Firms,19 May 2016
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