After fighting tooth and nail, Mexico’s state oil operator, the behemoth known as Pemex, managed last month to wrestle control of the country’s largest ever private oil discovery from the companies that discovered it. Eschewing even the option of a joint development, Pemex demanded, and received, sole operatorship of the Zama megafield. It was a decision that sent a statement, and that statement was ‘Mexico First’ in line with the government’s nationalist bent. And now, in the cruellest of ironies, reports seem to be confirming that Pemex does not have anywhere near enough cash to develop Zama over the next five to seven years.
It should be noted that Pemex had, in a letter to Mexico’s Energy Minister Rocio Nahle in early July stated that it had ‘sufficient financial capacity to develop the project. That letter, presumably, played a large role in the Energy Ministry’s final decision to award Pemex a 50.4% stake in the Zama field and operatorship. At that point, it seemed like a resolution to a conflict that dates back to 2018, when it was established that the Zama field – discovered by a Talos Energy-led consortium in the first private sector exploration well to be drilled in Mexico since 1938 – shared the same reservoir as one owned by Pemex. Total recoverable resources at Zama are estimated at nearly a billion barrels, with the commercialisation plan presented by Talos Energy calling for first oil by 2022 with peak production at around 100,000 b/d.
That is a huge prize, particularly for Pemex, which has been facing a chronic decline in its oil and gas output for decades. Whether it was conceit or deceit that drove it to wrestle control of Zama, Pemex may now have to contend with the reality that it won a battle but lost a war. Because it is estimated that the cost of developing Zama is nearly US$2 billion, cash that Pemex – already the world’s most indebted oil company – does not have. But instead of repairing bridges, Mexico seems to continue striking a pose it cannot afford. Options to overcome Zama’s funding challenges that would allow Talos Energy (now a minority stake holder in the Zama project) to provide financing using barrels as collateral were shot down by Pemex’s top brass and the Energy Ministry, viewing it as a threat to Mexican oil sovereignty.
How did Pemex get to this point? On the surface, you could blame the new government under President Andrés Manual López Obrador (AMLO) that has, since 2018, reversed many of the energy initiatives set up by his predecessor Enrique Peña Nieto. This included cancelling new oil auctions and axing reforms which has cast a chill over Mexico’s upstream industry that the international majors that were tempted there. After all, who wants to invest a country where the government can just seize assets on claims of sovereignty? But while AMLO seems to be operating in a dream world where the idea of Pemex’s power far exceeds its actual reality, the truth is far starker. Pemex is badly run, and has been badly run for many decades now.
Pemex is a state oil company, and like all state oil companies, it has been treated as a cash cow by the state since the oil industry was nationalised in 1938. In some case, say Equinor in Norway or Petronas in Malaysia, this relationship is benign, sometimes beneficial. But in some cases, say Pertamina in Indonesia, it can be less progressive. Pemex is the latter. In 2003, Pemex’s total debt stood at some US$63 billion. In 2020, despite the recovery in oil prices, total debt has now soared to over US$105 billion. That alarming level of indebtness is already causing a credit crunch: Pemex is facing problems raising cash to meet liabilities – including a vast pension system – while Moody’s has slashed its credit rating to junk citing ‘obvious logical contradictions’ in Pemex’s ability to balance revenue generation with debt servicing. It is already delaying payments to some private oil contractors, and its woeful ESG reputation, which has already restricted access to debt marketsm was further bruised by a fatal fire that broke out on the E-Ku A2 platform working on the Ku Maloob Zaap asset in the Gulf of Mexico. Instead of providing reassurances of safety, Mexico has instead prioritised production, ordering a return to full production by 30 August. That is how bad Pemex’s cash situation is.
In the meantime, crude production is declining and declining rapidly. Pemex’s current output is an estimated 1.7 mmb/d, almost half of what it was in 2004. Upon taking office in 2018, AMLO claimed he would bring Pemex’s production back to 2.4 mmb/d. That has not happened. The President than lowered the target to 2 mmb/d in March 2021 – arguing unusually that overexploitation would be bad for future generations. But that has also not happened. It should be noted that Mexico was the lone holdout among the wider OPEC+ club in the historic supply deal agreement in April 2020 to restrict supply in the face of Covid-19, preventing OPEC+ from reaching a symbolic 10 mmb/d cap, settling for 9.7 mmb/d instead.
Meanwhile, private crude production in Mexico is gaining. Tempted there in the wake of the 2013 Energy Reforms, key players such as Eni, Petrofac and Hokchi Energy have lifted independent crude production in Mexico to some 70,000 b/d in June 2021. Based on current plans and sanctions, private production could increase to 280,000 b/d in 2024 and over 400,000 b/d in 2028. Pemex, on the other hand, continues to struggle, with nearly half of its June 1.7 mmb/d output coming from five mature fields – Maloob, Zaap, Ayatsil, Xanab and Ku. Against this backdrop, it seems bizarre to act antagonistically against private oil players – since they are developing Mexico’s upstream industry where Pemex can’t – but here we are piling on the problems, Pemex has also committed to acquiring the Deer Park refinery in Texas from Shell and started construction of the massive US$10 billion Dos Bocas refinery, its seventh in the state of Tabasco, betting that refining will be key to process all the crude that Pemex has yet to produce to plug Mexico’s fuels gap.
The logical conclusion to the current scenario is that Pemex is bracing itself for a collapse. But it is ‘too big to fail’. Under AMLO’s administration, Pemex would have to be bailed out to preserve energy sovereignty. If the 2013 Energy Reforms was still intact, this could cushion the blow, and allow Mexico’s upstream industry to continue developing while Pemex restructures. Instead, Pemex seems to be barrelling towards a worst case scenario outcome that could infect the broader economy. The irony of winning Zama but being unable to finance its development is not a cause; it is a symptom of Pemex’s broader disfunction.
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On 10 December 2021, if all goes to plan Royal Dutch Shell will become just Shell. The energy supermajor will move its headquarters from The Hague in The Netherlands to London, UK. At least three-quarters of the company’s shareholders must vote in favour of the change at the upcoming general meeting, which has been sold by Shell as a means of simplifying its corporate structure and better return value to shareholders, as well as be ‘better positioned to seize opportunities and play a leading role in the energy transition’. In doing so, it will no longer meet Dutch conditions for ‘royal’ designation, dropping a moniker that has defined the company through decades of evolution since 1907.
But why this and why now?
There is a complex web of reasons why, some internal and some external but the ultimate reason boils down to improving growth sustainability. Royal Dutch Shell was born through the merger of Shell Transport and Trading Company (based in the UK) and Royal Dutch (based in The Netherlands) in 1907, with both companies engaging in exploration activities ranging from seashells to crude oil. Unified across international borders, Royal Dutch Shell emerged as Europe’s answer to John D Rockefeller’s Standard Oil empire, as the race to exploit oil (and later natural gas) reserves spilled out over the world. Along the way, Royal Dutch Shell chalked up a number of achievements including establishing the iconic Brent field in the North Sea to striking the first commercial oil in Nigeria. Unlike Standard Oil which was dissolved into 34 smaller companies in 1911, Royal Dutch Shell remained intact, operating as two entities until 2005, when they were finally combined in a dual-nationality structure: incorporated in the UK, but residing in the Netherlands. This managed to satisfy the national claims both countries make on the supermajor, second only to ExxonMobil in revenue and profits but proved to be costly to maintain. In 2020, fellow Anglo-Dutch conglomerate Unilever also ditched its dual structure, opting to be based fully out of the City of London. In that sense, Shell is following the direction of the wind, as forces in its (soon to be former) home country turn sour.
There is a specific grievance that Royal Dutch Shell has with the Dutch government, the 15% dividend tax collected for Dutch-domiciled companies. It is the reason why Unilever abandoned Rotterdam and is now the reason why Shell is abandoning The Hague. And this point is particularly existentialist for Shell, since its share prices has been battered in recent years following the industry downturn since 2015, the global pandemic and being in the crosshairs of climate change activists as an emblem of why the world’s average temperatures are going haywire. The latter has already caused the largest Dutch state pension fund ABP to stop investing in fossil fuels, thereby divesting itself of Royal Dutch Shell. This was largely a symbolic move, but as religious figures will know, symbols themselves carry much power. To combat this, Shell has done two things. First, it has positioned itself to be at the forefront of energy transition, announcing ambitious emissions reductions plans in line with its European counterparts to become carbon neutral by 2050. Second, it is looking to bump up its dividend payouts after slashing them through the depths of the Covid-19 pandemic and accelerating share buybacks to remain the bluest of blue-chip stocks. But then, earlier this year, a Dutch court ruled that Shell’s emissions targets were ‘not ambitious enough’, ordering a stricter aim within a tighter timeframe. And the 15% dividend tax remains – even though Prime Minister Mark Rutte’s coalition government has been attempting to scrap it, with (it is presumed) some lobbying from Royal Dutch Shell and Unilever.
As simplistic it is to think that Shell is leaving for London believes the citizens of the Netherlands has turned its back on the company, the ultimate reason was the dividend tax. Reportedly, CEO Ben van Buerden called up Mark Rutte on Sunday informing him of the planned move. Rutte’s reaction, it is said was of dismay. And he embarked on a last-ditch effort to persuade Royal Dutch Shell to change its mind, by immediately lobbying his government’s coalition partners to back an abolition of the dividend tax. The reaction was perhaps not what he expected, with left-wing and green parties calling Shell’s threat ‘blackmail’. With democracy drawing a line, Shell decided to walk; or at least present an exit plan endorsed by its Board to be voted by shareholders. Many in the Netherlands see Shell’s exit and the loss of the moniker Royal Dutch – as a blow to national pride, especially since the country has been basking in the glow of expanded reputation as a result of post-Brexit migration of financial activities to Amsterdam from London. The UK, on the other hand, sees Shell’s decision and Unilever’s – as an endorsement of the country’s post-Brexit potential.
The move, if passed and in its initial stages, will be mainly structural, transferring the tax residence of Shell to London. Just ten top executives including van Buerden and CFO Jessica Uhl will be making the move to London. Three major arms – Projects and Technology, Global Upstream and Integrated Gas and Renewable Energies – will remain in The Hague. As will Shell’s massive physical reach on Dutch soil: the huge integrated refinery in Pernis, the biofuels hub in Rotterdam, the country’s first offshore wind farm and the mammoth Porthos carbon capture project that will funnel emissions from Rotterdam to be stored in empty North Sea gas fields. And Shell’s troubles with activists will still continue. British climate change activists are as, if not more aggressive as their Dutch counterpart, this being the country where Extinction Rebellion was born. Perhaps more of a threat is activist investor Third Point, which recently acquired a chunk of Shell shares and has been advocating splitting the company into two – a legacy business for fossil fuels and a futures-focused business for renewables.
So Shell’s business remains, even though its address has changed. In the grand scheme of things, never mind the small matter of Dutch national pride – Royal Dutch Shell’s roadmap to remain an investment icon and a major driver of energy transition will continue in its current form. This is a quibble about money or rather, tax – that will have little to no impact on Shell’s operations or on its ambitions. Royal Dutch Shell is poised to become just Shell. Different name and a different house, but the same contents. Unless, of course, Queen Elizabeth II decides to provide royal assent, in which case, Shell might one day become Royal British Shell.
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