After three days of negotiations, Mexico on Saturday had yet to completely acquiesce to demands the country play its role in helping to restore some sense of stability to an oil market in turmoil.
The OPEC+ alliance had otherwise agreed to a deal that curbs output by a massive 10 million barrels per day, no small feat considering the acrimony between Riyadh and Moscow headed into this week’s talks, which were conducted largely via teleconference.
The issue for Mexico is straightforward, apparently. “Pemex is the centerpiece of [Andres Manuel Lopez Obrador’s] efforts to become self-sufficient in energy generation and stem a 15-year decline in production”, Bloomberg notes, adding that if the national producer were to cut by 400,000 barrels per day as mandated by the OPEC+ deal, it would “put on hold [AMLO’s] ambitious plan to return Pemex to its past glory”.
AMLO was also emboldened by Pemex’s hedging program.
He did offer to cut production by 100,000 barrels, before going an unorthodox route: He asked Donald Trump to make up the difference. Trump agreed, with no strings attached, where that means the US would cut output by around 250,000 barrels per day.
There are two things worth noting.
First, even 10 million barrels per day isn’t going to make up for the near-term demand destruction caused by the coronavirus containment measures adopted globally. Estimates vary, but the range is somewhere between 20 million and 30 million barrels per day.
The latest US data on the supply of finished motor gasoline shows a plunge to levels never witnessed in figures back to February of 1991, last week’s stock build was the largest on record according to the EIA and daily air passengers in the US have plunged by 96%, according to TSA data. That gives you a sense of how vexing this problem really is.
In short: There is no production cut large enough to balance this market in the near term, so the “Mexican standoff”, as it were, over 300,000 barrels seems patently absurd.
Second, this is really just a shell game for Trump. The US president has variously suggested the country is already cutting production (or will be soon) due to the uneconomic conditions for E&Ps at current prices – or something. The idea, in Trump’s mind anyway, is that he can count those assumed lost barrels towards the cuts he’s agreed to make on behalf of Mexico.
On Friday, Trump claimed Mexico would “reimburse” the US for the favor. The time table on that isn’t clear. Trump would say only that the US will be paid back “sometime at a later date when [Mexico] is prepared to do so”. In other words: Never.
And it’s far from clear what “reimbursement” would mean in this context. It’s not as if Mexico is going to be inclined to cut checks to US energy companies down the road, and even if you inexplicably believe some compensation is, in fact, forthcoming, it would come far too late.
Consider, for example, that major US banks are reportedly on the verge of seizing energy assets from an industry which owes a combined $200 billion to lenders. Those loans are collateralized by oil and gas reserves.
“JPMorgan, Wells Fargo, Bank of America and Citigroup are each in the process of setting up independent companies to own [the] assets”, Reuters says, citing a trio of sources who aren’t cleared to speak publicly, for obvious reasons. The sources also told Reuters that “the banks are looking to hire executives with relevant expertise to manage them”.
Why, you might fairly ask, would banks want to operate energy subsidiaries amid the worst industry downturn in recent memory?
The answer is, they wouldn’t – want to get into the energy business, that is. But they don’t have a choice. Because the alternative is seizing the assets and then selling them for what, at current prices, would be “pennies on the dollar”, Reuters writes.
Banks will need regulatory approval for the move, and will apparently lean on the excuse that their actions would be beneficial to the economy and aren’t related to an industry seeking a federal bailout.
It’s been decades since banks have gone this route, Reuters goes on to say, but due to the exigent circumstances created by a looming deep recession and the prospect of taking massive haircuts in restructuring, lenders may resort to drastic measures unless the value of collateral recovers by the time the vehicles for owning and operating seized assets are up and running (likely several months).
“Banks typically lend money to oil and gas producers against their proven reserves in the ground [and] those borrowing bases are typically re-determined twice a year – in April and November”, Bloomberg wrote, in an expansive March 26 piece, which reminds you that “the appraised value of oil and gas reserves in the ground is highly dependent on forward oil prices, and are written down with declines”. The situation is exacerbated by limited access to capital when debt markets slam shut for companies caught in the storm.
(BBG; debt distribution of reserve-based loans to oil and gas producers)
Although market conditions have improved over the past two weeks, the number of distressed bonds traded jumped to nearly 1,900 in late March, according to TRACE data.
That was nearly double the number from early 2016, and easily the highest since the GFC years. Not surprisingly, the trouble was concentrated in the energy sector, where more than $150 billion in troubled debt lies.
All of that underscores how perilous the situation is for many debt-laden US oil and gas companies, and in turn why Donald Trump is determined to ensure the production cuts agreed by OPEC+ go ahead.
A statement issued after a G-20 call on Friday was largely nebulous, with participants agreeing to take “all the necessary measures” to balance production and consumption. There were no specifics. For now anyway, the burden of rebalancing the market falls on the OPEC+ agreement.
“We are trying to get Mexico, as the expression goes, over the barrel”, Trump said, at the same Friday press briefing. It wasn’t clear whether the president understood the meaning of that expression.
Asked about Trump’s “reimbursement” comment, Mexico’s Energy Minister Rocio Nahle told Radio Formula she wasn’t aware of any such plans.
“Mexico and the US are neighbors”, she said. “I want to think that President Trump was referring to that, that we would offer something in thanks”.
Trump can use the reimbursement from Mexico to pay for the WALL. In the future.
I’m guessing banks will seize smaller operations without sufficient cash and then big players will buy them from banks in a year or two when prices spike. Banks are unlikely to do much other than handling paperwork. Which means they’ll likely also need more bailouts.
The night the Russians announced an attempt to curtail US Oil Trump said nothing. I think Mexico agreed to be a punching bag at election time.
This is a weird deal by the banks. I do not see how it is beneficial to the economy if it not a bailout of the industry. Since you have defaulted on your mortgage we are going to take your property and pay you to manage it for us. It smell of fracking by products blowing on the wind. I see a pr campaign in the distance and why would anyone question how these banks have found themselves in such a mess again.
“Banks setting up independent companies to own the assets” …. unless the banks write down the value of the loans (assets to the banks) or the foreclosed assets- this is totally a sham.
If the “independent companies” are not consolidated on the balance sheets of the lenders- I will remain quite skeptical.
From “10,000 feet”, as Fauci said- the virus will set the timeline for a return to economic activity.
Based on the USA’s track record for the roll out of masks and testing (viral and antibody)– even if medical scientists develop a vaccine in 12-18 months, we have to hope the virus does not mutate and they have to produce enough vaccines and administer- probably not happening overnight.
Federal Reserve playing “whack-a-mole”, but with the tsunami of problems on the horizon, it seems like the Federal Reserve/government will run out of bullets before we are resurrecting our economy in a meaningful way.
Make sure you are sheltering in place with someone you might have to spend 24/7 with for the next 12-18 months. This could be amazing or very terrible!
Mexico could end up building the wall.
nice
In Southern California in 1993 or 1994, I used the phrase “Mexican standoff” in a conversation with a Latino co-worker. He promptly informed me that this phrase was derogatory and racially bias. I see it’s use in the heading to this article may in fact be literally correct…
Mexico hedges essentially its entire oil production. A recent Bloomberg article said that the hedge is probably at around $45. So Mexico has no reason to cut production. Trump can pressure Mexico via tariffs etc, Mexico can retaliate, its probably not a road worth going down.
If banks are going to seize defaulting oil companies’ production facilities and reserves, Treasury can do a deal to idle that production and produce the cut that the US agrees to make.