Oh, Mexico!

Position: We are short Mexico via the etf EWW

“Baby's hungry and the money's all gone
The folks back home don't want to talk on the phone
She gets a long letter, sends back a postcard; times are hard”

-           James Taylor – Mexico

We’ve been negative of Mexico for most of the past year and have been in and out of her on the short side a number of times.  Rock and roll musician James Taylor sings the well known song Mexico, which is excerpted above.  While JT is referring to a lover from Mexico, the excerpt could just as easily be referring to the potential for increased fiscal issues in Mexico.

We are bearish on oil in the intermediate term and this is major problem for Mexico.  The Mexican oil industry is a monopoly controlled by state owned Pemex. On one hand, Mexican production of oil is in decline, which is bad for Mexico.  In fact, in 2009 Mexican production was 2.6MM barrels per day, which is its lowest level since 1990 and 6.8% less than the prior year.  In addition to that, any decline in the price of oil will also negatively impact state revenues.

As we have noted in the past:

“To this day, PEMEX owns and operates all of Mexican oil production and is a meaningful contributor to the Mexican economy. In 2007, Mexican oil exports contributed 10% of Mexican export revenue. PEMEX pays out over 60% of its revenue to the Mexican state in the way of royalties and taxes. In aggregate, PEMEX contributes almost 40% of the federal government's budget. Despite record oil prices over the last few years, the Company has a substantial debt balance estimated at over $42.5BN as the vast majority of profits have gone to the government rather than to pay down debt, let alone investing in the business.”

A decline in oil is clearly bad for Mexico. In 2009, the country posted a fiscal deficit of $20.1BN and even with a projected growth rate of 3% in 2010 it is likely that the deficit will continue.  To offset her budget gap  . . . you guessed it . . .Mexico issued sovereign debt. On January 11th of this year, Mexico issued $1BN in 10-year bonds at an interest rate of 5.25%.  This was her first offering since the credit rating of Mexico was cut by Fitch and Standard and Poor’s to BBB.

Declining oil revenues, burgeoning deficit, and increased debt. Oh Mexico, indeed.

Daryl G. Jones
Managing Director