Fitch Rates Pemex's Euro 2.25 Billion Issuance 'BBB+'

CHICAGO--()--Fitch Ratings has assigned a 'BBB+' Long-term rating to Petroleos Mexicanos' (Pemex) Euro 2.25 billion senior unsecured debt issuance composed of:

--Euro 1,350 million due in three years;

--Euro 900 million due in seven years.

The company expects to use the proceeds from the issuances to finance its investment program and working capital needs; also to refinance indebtedness. The debt issuances are guaranteed by Pemex Exploracion y Produccion; Pemex Transformacion Industrial; Pemex Perforacion y Servicios; Pemex Logistica; and Pemex Cogeneracion y Servicios.

KEY RATING DRIVERS

Pemex's ratings reflect its close linkage to the government of Mexico and the company's fiscal importance to the sovereign. Pemex's ratings also reflect the company's competitive pretax cost structure, national and export-oriented profile, sizable hydrocarbon reserves and its strong domestic market position. The ratings are constrained by Pemex's significant unfunded pension liabilities, substantial tax burden, large capital investment requirements, negative equity and exposure to political interference risk.

Strong Linkage to the Government

Pemex is the nation's largest company and one of the Mexican central government's major sources of funds. During the past five years, Pemex's transfers to the government have averaged 49.0% of sales, or 168.0% of operating income. These contributions, through royalties, exploitation, taxes and production duties have averaged 30% to 40% of government revenues. As a result, Pemex's balance sheet has weakened, which is illustrated by its negative equity balance sheet account since the end of 2009. Despite pari passu treatment with sovereign debt in the past, Pemex's debt currently lacks an explicit guarantee from the government.

Oil Production Decline Stemmed

Currently at approximately 2.3 million barrels per day (bb/d), crude oil production has continued to marginally decline in recent years, although not at the same speed as it did during a precipitous fall in 2008 - 2009. Natural gas production excluding nitrogen has been relatively stable during recent years at approximately 5.5 billion cubic feet per day (bcf/d). Pemex has been able to stem production decline through more intensive use of technology in the Cantarell field, improvements in operations, and increased production from a diversified number of fields.

The diversification of the oil production asset base, with Cantarell representing less than 15% of oil production, reduces the risk of large production declines in the future. The company's previous goal was to increase total crude production to three million bpd in the medium to long term, which in Fitch's view was prove challenging. Pemex's current goal is to maintain production at present-day levels of 2.2 million bpd.

Energy Reform; Long-Term Positive for Pemex

Although Pemex's credit ratings will continue to be highly linked to those of the sovereign, the reform would likely give the company financial flexibility through budgetary independence. Before the implementation of the energy reform, the company budgetary approval process from congress, coupled with high tax burden, hindered the company's investment flexibility. Also, the company would benefit by being able to partner with oil and gas companies in order to share exploration risk.

The overall impact on the reform for Pemex will be positive but gradual and the company will continue to face heavy tax burden in the medium term. The energy reform would also benefit the company's capital structure after the recently announced estimated reduction on Pemex's pension liabilities of approximately USD11 billion, which the government is expected to match. At the end of 2015, the pension obligations amounted to approximately USD74.4 billion.

On Dec. 24, 2015, the government injected approximately USD2.9 billion in the form of non-tradable notes maturing in 2050. Towards the end of 2015 the company reached an agreement to change its pension plan into a defined contribution from a defined benefits plan and increased the retirement age for unionized employees that have been with the company for less than 15 years and all non-unionized employees to 60 years of age and 30 years of service, from the previous 55 years of age and 25 years of service.

Negative Free Cash Flow Due to Capex

Fitch expects the company to present negative free cash flow (FCF) over the foreseeable future, considering Fitch's price deck, as it continues to implement capital investments to sustain and potentially increase current production volumes, as well as continue implementing large transfers to central government in the form of very high duties, royalties and taxes. The company's historical significant tax burden has limited its access to internally generated funds, forcing a growing reliance on external borrowings. At the end of 2015, Pemex's funds from operations, calculated by Fitch, were approximately negative USD2.5 billion and net operating cash flow was approximately positive USD2.3 billion, which compared with cash capital expenditures of USD14.9 billion, resulting in negative FCF of USD12.6 billion.

Adequate Pre-Tax Credit Metrics

At the end of 2015, Pemex's EBITDA (operating income plus depreciation plus other income) was approximately USD12.0 billion. Leverage as measured by total debt-to-EBITDA was 7.3x. Pemex cash flow metrics are weak due to the company's high cash transfers to the government in the form of taxes and production duties. As of December 31, 2015, total debt was USD86.8 billion.

KEY ASSUMPTIONS

Fitch's key assumptions within our ratings case for the issuer include:

--WTI crude prices average USD45 per bbl in 2016, increasing to USD65 per bbl by 2018 in the long term.

--The company continues to face difficulties increasing its production over the next four years.

RATING SENSITIVITIES

An upgrade of Pemex could result from an upgrade of the sovereign coupled with a continued strong operating and financial performance and/or a material reduction in Pemex's tax burden. Negative rating action could be triggered by a downgrade of the sovereign's rating, the perception of a lower degree of linkage between Pemex and the sovereign, and/or a substantial deterioration in Pemex's credit metrics.

LIQUIDITY

Pemex has adequate liquidity of USD6.3 billion as of December 31, 2015. The company has committed revolving credit lines for USD4.5 billion and MXN23.5 billion; at the end of 2015 USD130 million and MXN9.1 billion were available. The company's debt is well structured, with manageable short-term debt maturities. The company's liquidity is further bolstered by its robust pre-tax cash flow generation supportive by its competitive operational cost structure. Fitch estimates Pemex's operating cash cost to be less than USD23 per barrel of oil equivalent, including interest costs and full allocation of administrative expenses to the upstream business.

FULL LIST OF RATINGS

Fitch currently rates Pemex as follows:

--Long-term IDR 'BBB+'; Outlook Stable;

--Local currency long-term IDR 'A-'; Outlook Stable;

--National long-term rating 'AAA(mex)'; Outlook Stable;

--National short-term rating 'F1+(mex)';

--Notes outstanding in foreign currency 'BBB+';

--Notes outstanding in local currency 'A-';

--National scale debt issuances 'AAA(mex)';

--Short-term Certificados Bursatiles Program 'F1+(mex)'.

Date of Relevant Rating Committee: November 24, 2015

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

Additional Disclosures

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1000844

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
Lucas Aristizabal
Senior Director
+1-312-368-3260
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Alberto De Los Santos
Associate Director
+52 81 8399 9100
or
Committee Chairperson
Joe Bormann
Managing Director
+1-312-368-3394
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Lucas Aristizabal
Senior Director
+1-312-368-3260
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Alberto De Los Santos
Associate Director
+52 81 8399 9100
or
Committee Chairperson
Joe Bormann
Managing Director
+1-312-368-3394
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526
elizabeth.fogerty@fitchratings.com