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Drop in oil prices forces Mexico to slash $8.4B from its 2015 budget

Drop in oil prices forces Mexico to slash $8.4B from its 2015 budget

Posted by Juan Gavasa on February 11, 2015

The lowest oil prices in nearly six years couldn't have come at a worse time for Mexico, which last year opened up oil-sector investment to private companies for the first time in decades.

The landmark energy reform aimed to boost revenue by enabling Mexico to tap undeveloped fields and adopt newer technology to reverse a decade-long slide in production.

Instead, the drop in oil prices has forced Mexico's government to slash $8.4 billion from its 2015 budget, with most of the cutbacks expected to come in the energy sector. Analysts predict the energy partnerships made possible by the reform will attract initial bids lower than anticipated, some exploration projects will be delayed, and state oil company Pemex will see a cash crunch and slow job growth.

"If we continue for the next year in the scenario that we're currently in today, it will have an impact because Pemex, i.e. Mexico, will not be getting the same revenues that it's getting out of their current production," said Jorge Pinon, an oil and energy analyst at the University of Texas. "That's simple arithmetic."

It all adds up to another political headache for President Enrique Pena Nieto and his Institutional Revolutionary Party, or PRI, as it heads into June's midterm elections. The oil downturn comes as Mexicans protest the September disappearance of 43 college students, allegedly murdered by a drug gang in league with local police, and critics deride Pena Nieto, his wife and his finance minister for buying luxurious properties from government contractors.

"Given the very mediocre performance of the economy in the last two years, they were hoping for a better showing in order to arrive at the ballot box with something to show," said Dwight Dyer, a senior analyst for Mexico and the Americas at Control Risks in Mexico City. "This puts significant pressure on the PRI electorally."

After trading at a high of $115 a barrel last year, oil plummeted to around $44 a barrel in late January, the lowest since April 2009. U.S. benchmark crude recovered somewhat to more than $50 a barrel this week, but some industry analysts say prices may not yet have found their floor with a worldwide glut still in place and global economic growth sluggish.

How long oil remains in the basement — or how long the industry believes it will — stands to affect private bidding on exploration, development and optimization contracts in Mexico this year.

Pinon said oil would have to be around $77 a barrel for some of the Mexican projects to be profitable. So shale deposits, for example, will be less attractive as long as potential investors have doubts about price.

Other projects such as deep-water exploration in the Gulf of Mexico, which can take three to five years to begin producing, still are likely attractive for major operators able to bet that prices will rebound by the time the oil starts flowing.

The National Hydrocarbons Commission, which runs the bidding process, says 16 companies including Exxon Mobil, Chevron, BP and Shell have expressed interest in 14 shallow-water offshore blocks up for bid this spring.

In the medium to long term, Mexico's reform almost certainly will improve the energy sector and overall economic performance, Dyer said. But for now, oil's slump stands to "kick the can down the road," especially for shale, which is more technically challenging.

"Looking at the prospects at this moment, it looks like a tough situation," he said. "I wouldn't say this will derail energy reform, but rather the expectations will have to be adjusted toward lower bids than expected, less investment."

Mexican Treasury Secretary Luis Videgaray said recently that bidding on unconventional projects likely would be delayed.

The Mexican government relies on oil revenue for about a third of its spending and calculated this year's budget based on an average price of $79 a barrel. The $8.4 billion cut it made from its budget represented roughly 3 percent of projected spending and will be noticeable. Cuts include major infrastructure projects, including a high-speed rail project between the capital and the growing industrial center of Queretero that also was tainted by the conflict-of-interest allegations.

The cutbacks also will affect Mexico's working class — would-be beneficiaries of the federal pension system, educational and other workers who make up the base of the ruling party.

Mexico's pain could have been much worse without an aggressive hedging program in futures markets that it has pursued for years even when oil soared above $100 a barrel. The country locked in a price of $76.40 a barrel for much of its 2015 production, essentially giving it insurance against the vagaries of international markets.

The country is protected from further cuts due to oil price fluctuations, said Fernando Aportela, undersecretary of the Treasury Department. But he acknowledged that the budget may have to be adjusted again if Pemex does not meet production targets.

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