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Taxes Bleeding Mexico's Pemex Dry, Fitch Says

The Mexican government is taxing Petroleos Mexicanos (Pemex) to death, and a recently adopted support package to prop up Pemex is not enough, Fitch Ratings said in a note last week.

Pemex faces insolvency because of taxes, insufficient government support, as well as the long-term effects of capital spending reductions, according to a new Fitch Ratings sensitivity analysis.

"The Mexican government's continued demand for dividends from Petroleos Mexicanos (Pemex) in the form of taxes will force the company to borrow at an unsustainable pace,” said Lucas Aristizabal, Fitch senior director. "Essentially, Pemex borrows 100% to pay taxes versus the government borrowing directly from investors to fund its deficit, at lower cost.

"Pemex's taxes ensure it will likely transfer all of its EBITDA in 2016, while making it improbable that the company would have positive free cash flow in the foreseeable future," Aristizabal added. "The recently announced support package from the government [see Daily GPIAug. 18April 13], although a step in the right direction, was insufficient to make the company self-sustainable."

Pemex's direct oil and gas production costs are very competitive, providing little room to lower replacement costs, Fitch said. A prolonged reduction in expenditures and investments increases operational risks and jeopardizes long-term viability. Reductions of pension cash outflows are difficult, and employee layoffs will have minimum savings on cash outflows.

"Pemex's capital investments have been below implied replacement costs and not enough to stem production decreases," Fitch said. "The announced investment cuts will likely restart the production decline and proved reserves and reserve life could also decline."

The national oil company's free cash flow "...will be negative under any oil price scenario if it were to replenish reserves as they are produced," Fitch said.

"Fitch estimates Pemex's after-tax breakeven prices for 2014 and 2015 were US$82/boe and US$57/boe, respectively. Divestitures could ease pressure but will yield no long-term benefits if the proceeds are divided out instead of reinvested in profitable assets. Joint ventures are beneficial only in the very long term, and Pemex could run into financial difficulties before seeing the benefits of partnerships."

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