Mexico’s global oil market win amid Covid-19 price drop

Following a coronavirus-related fall in crude prices, oil-producing nations have sought to calm global markets by announcing a significant production cut, with Mexico standing to benefit from a special dispensation in output after striking a deal with the US. 

The borders between the two countries remain open, albeit only to essential traffic. Mexican airspace is also open to both cargo and passenger flights, in contrast to some other countries in Latin America such as Peru and Colombia, which have closed their borders. 

Although Mexico as a whole is not experiencing a total lockdown, some social distancing measures -as outlined by the various state governments- are in place. On April 16 in the daily news conference of President Andrés Manuel López Obrador, known as AMLO, the deputy minister of prevention and health promotion, Hugo López-Gatell, said that existing social distancing measures would be extended until May 30. 

Since mid-March the Covid-19 outbreak has caused a sharp drop in global demand for oil and, as a result, its price on global markets has fallen significantly. This was then exacerbated by a price war between Saudi Arabia and Russia, which brought the price down below $25 a barrel in early April. 

However, as part of an effort to stem the fall in oil prices, on April 12 members of the Organisation of Petroleum Exporting Countries (OPEC), along with some other allied states, agreed to a landmark deal that would reduce total global output by 9.7m barrels per day (bpd), equivalent to around 10% of global production, from May onwards. 

After days of negotiations, it was agreed on April 14 that Mexico would reduce output by 100,000 bpd, just one-quarter of its allocated share as proposed in the initial 23-nation OPEC+ agreement. 

This is thanks to a deal that will see the US cut an additional 300,000 barrels on Mexico’s behalf. While AMLO has claimed that Mexico will “reimburse” its northern neighbour at a later date for the cuts, no public statement has been made on how this will be achieved. “It went very well for us - really well”, AMLO told reporters at his daily morning press conference on April 13. “Mexico had special treatment. It was respected by the group of oil-producing nations.” 

The president’s strategy can in part be explained by his desire to boost domestic refinery capacity, which he hopes to increase by an extra 400,000 bpd as part of a wider bid for energy self-sufficiency. At present, imports from the US account for around 65% of all Mexican demand. 

Mexico’s decision to hedge its oil prices at $49 a barrel this year is also thought to have been another factor behind the government’s attempt to scale-back production cuts. Although there was no specific information on how many barrels were hedged, the deal usually covers between 200m-300m barrels.  

The move creates uncertainty about how much longer Mexico will remain part of OPEC+. International media has reported that a decision will be made within the next few months about whether to remain part of the international cartel. While the move is undoubtedly a short-term win for AMLO and Mexico, it is unclear how the decision will play out with other oil producers in the coming months. 

The global drop in oil prices comes at a time when Petróleos Mexicanos (Pemex), Mexico’s national oil company, faces one of its greatest fiscal challenges to date. With over $100bn of debt, it is the world’s most indebted oil company, and its revitalisation has been central to AMLO’s nationalist economic rhetoric. 

Pemex’s oil production peaked at 3.4m bpd in 2004 but has fallen significantly over the past 15 years, averaging 1.7m bpd last year. Following a challenging 2019 that resulted in international credit ratings agency Fitch downgrading Pemex’s bonds to speculative grade, or junk, Moody’s Investor Service had said in late February that it expected Mexico’s crude oil production to rise by 1% this year.  

However, in the intervening months, as the full effects of the pandemic have been made clear, Pemex’s financial position has become less favourable. Even with the strategically negotiated hedge, a sustained period of $30-a-barrel oil could lead to a negative cash flow of $20bn for the company, according to Bank of America analysts, which in turn could lead to a further downgrading of Pemex’s bonds by the other main ratings agencies. AMLO has since moved to reassure markets, stating on April 5 that he would reduce Pemex’s tax burden by a further MXN65bn ($2.7bn).