Falling Oil Prices: Risks to Mexico

Falling Oil Prices: Risks to Mexico
2015-2016: The impact of Oil Prices on the Mexican Economy is complex. This overview should not be relied upon for decision making purposes. Readers are advised to seek professional advice prior to making financial decisions based upon its content.
Written: March 19, 2015

Update: January 11, 2016

Oil Prices and Outlook

Oil prices have stabilized somewhat around the $60 per barrel mark, and recently has shown lower volatility than what we have seen in the last 6 or 7 months.

But another Oil Price Collapse could be just over the horizon. That is because oil producers are starting to run out of storage. Production has soared yet global demand has failed to keep up. Oil producers have been putting oil into storage tanks at an incredible rate since the summer of 2014. Total inventories now have reached well over 400 million barrels. That is the highest level of oil sitting in storage in over 80 years! It is 20%+ higher than the five-year average. The U.S. is pumping so much oil it's running out of places to stash it. The bottom line is that inventories are growing…and that is creating risk of another slump in oil prices. Once storage hits capacity, the drop could be precipitous.

There are two key points. First, oil production has not leveled off, despite several months of prices below the break even mark for many producers, including Mexico. Secondly, U.S. producers may soon start to top off their storage tanks. If production does not decline and oil storage capacity runs out, the glut of oil on the market could worsen pretty quickly, sending prices down once again.

Impact on Mexican Economy

Today’s lower prices are already hurting the economies of oil producing countries such as Mexico. In December 2014, the U.S. Center for Geoeconomic Studies stressed that Mexico depends on oil exports with one-third of the federal budget funded by oil revenues generated through Pemex. The break even point for Mexico on oil prices appears to be about $70+ per barrel. We have been well below that for some time, and a dramatic decline  due to over-supply will create a real strain on Mexico’s economic revenue. Tax on oil and gas accounts for about 30% of Mexico's total tax revenue.

Mexico has some contracts that guarantee it a fixed price for some of its oil sales. But this protection is not complete, particularly against any price decline, or prices below the break even mark, that continues for more than a year. In the event of renewed falling oil prices, or continued prices below the break even point, the Mexican government will need to take on new debt which means issuing bonds...and that creates problems for a country already experiencing economic challenges. The alternatives include raising revenues, or cut spending. Each would create political and economic challenges.

The first crack in the shell may have already started. Guadalajara recently pulled the plug on the $100 million 2017 World Aquatics Championships as a result of falling revenues. Falling oil prices and a difficult global economic environment have definitely put a damper on expectations for Mexico’s economy.

The Equity Fund Flow out of Mexico has been accelerating for the past 12 month and has reached upwards of $2.5 Billion weekly in February 2015. Equity Fund Flow is a measure of investment into or out of a country. Clearly, investor confidence in Mexico is sliding significantly.

Mexican Bonds

Other oil exporters are also suffering. Norway, Brazil, Russia all show signs of strain. Brazil’s state-owned oil company (Petrobras) has recently had its credit rating slashed to “junk” status. It is not unrealistic to worry that the same could happen to Mexico’s Pemex if things don’t improve. Mexico bond prices may be expected to melt if that happens.

Many expats are looking at the nice interest rates compared to what they can expect back home, and many feel safe investing with "bonds". However, investors need to be wary of the fact that higher interest rates on bonds are a sign that there is higher risk. In 1994, the Mexican Peso was devalued by 50%. Bonds retained their coupon rate, but dropped 50% in capital value relative to the USD. It may be nice to have 8% bond coupons, but if the relative value of bonds drops 50%, say goodbye to your capital.

Impact on Mexican Peso

Mexico’s Peso value has already dropped by 13.1% during the course of 2014. Focus Economics reports that the Mexican peso experienced a rapid depreciation in first months of 2015 due in part to the slide in global oil prices.

At the end of February 2015, the Mexican peso traded at 14.95 MXN per USD, which was virtually unchanged compared to the 14.99 MXN per USD registered at the end of January. Nonetheless, the Mexican currency lost 12.7% of its value against the U.S. greenback in annual terms in February and continued to fall uninterruptedly. On 10 March, the peso experienced its biggest one-day drop and closed the day at 15.63 MXN per USD, a multi-year low. (Update - January 11, 2016 - the peso-to-USD rate is 17.83 today.)

The growth in the Bolsa has been about 11% over the past 12 months, but the peso has lost a lot more than that meaning that U.S. and Canadians would have done a lot better…a lot better…if they invested back home. That is not unusual. Too many foreign investors lose sight of the currency risk when investing on the Bolsa exchange.

The question becomes, is there a growing risk of a major currency devaluation on the horizon such as was experienced in the 1990’s following the collapse of global oil prices at the time? That would be disastrous to expats, snowbirds or retirees who hold any significant amount in pesos.

Defensive Options

The risks are fairly obvious... a declining peso, continued Equity Fund Out-Flow, and increased downward pressure on the Mexican economy. For foreigners who can move cash out of Mexico and invest it into other currencies, this may be the warning shot telling you to give that idea some serious thought.

As mentioned in the beginning of this article, the impact of Oil Prices on the Mexican Economy is complex. This overview should not be relied upon for decision making purposes. Readers are advised to seek professional advice prior to making financial decisions based upon its content.

For Canadians with non-resident status, it may prove difficult to move capital back into their home country. Most financial institutions in Canada will not open new accounts for non-residents although a skilled financial advisor may be able to offer some options. One such option for Canadians may be moving your money back to Canada and purchasing a Guaranteed Income Pension with your savings.

This article has been compiled by a Certified Financial Planner (CFP) who assists Canadians design portfolios for their life abroad. His extensive experience has helped 100's of Canadians move to Mexico since 1999. If you need advice or have questions, please contact our office for a no-cost consultation.

For Canadians who wish a no-cost consultation.  Please have a Canadian Financial Advisor contact me.

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