MEXICO
Mexico is a special case. On the face of it the low oil price is very bad for the country, which has averaged production of about 2.8 million barrels of oil per day over the last five years. “The Mexican economy has been weighed down by low oil prices and reduced oil production,” says the World Bank in its 2016 outlook on the region. “Lower oil prices have severely curtailed government revenues and compelled fiscal tightening.”
However, it’s not quite that simple. Although Mexico is the third-largest crude oil exporter in the Americas, it is also a net importer of refined products, chiefly gasoline and diesel. On top of that, it has a different trade relationship mix than South American countries and a broader economy than many of them.
“We see Mexico as an exception in the LatAm world as, contrary to its neighbours, it relies more on US growth than Chinese growth,” says Xavier Hovasse, head of emerging equities at asset management group Carmignac Gestion.
To Alejandro Hardziej, fixed income analyst at Julius Baer, Mexico is one of the better placed economies in the region, “because they have the lowest exposure to commodities and what they export is normally manufactured goods to the US.”
This reliance on the US over China hasn’t always been to Mexico’s benefit in recent years but with America apparently recovering and China slowing, the winds are now in Mexico’s favour.
Coface, the French export credit agency and worldwide credit insurance group, says that “Mexico tends to be the least impacted by lower Chinese demand,” with exports to China accounting for just 0.5% of Mexico’s GDP. Consequently a Chinese slowdown has not had as sharp an effect directly on Mexico as on others (though it has, of course, been a central contributing factor to the oil price being low at all), whereas expanding exports to a recovering USA caused growth rates to rise modestly in 2015 where in most other parts of the region they fell.
On top of that, oil is not absolutely central to Mexico’s economic fortunes. “Mexico is very interesting,” says Maarten-Jan Bakkum, senior emerging market strategist at NN Investment Partners. “They are of course exporting oil but their oil exports as a percentage of GDP have declined.” Oil revenues as a proportion of total government revenues have dropped from 30% to 25% over the last few years. “Still, if 25% of revenues are related to oil, you can understand that weak oil prices do put pressure on them. What we’re seeing is that low oil prices have forced the government to cut spending to prevent the fiscal deficit from rising.”
And this is the other point: Mexico has developed a reputation, at both government and central bank level, for being prudent and willing to do what is necessary. “Mexico’s domestic economy still has issues, but President Peña Nieto’s mandate to drive investment should help the industrialisation of the country over the long term,” says Hovasse.
Hardziej adds: “GDP numbers during the last few quarters have been very stable. Yes, there is both a fiscal deficit and a current account deficit but it is nothing to be overly concerned about.”
Better still, it is insulated from commodity price movements through other areas of its exports mix. “Mexico remains an under-geared economy with potential improvements to its export industry given its cost competitiveness, even versus China,” says Hovasse. “Valuations are a bit expensive, but not excessive, and the currency has already taken a big hit.” And Bakkum agrees. “Its export sector is super-competitive,” he says. “I like the Mexican market. Investors have been too negative on it recently. It’s tricky and it has a lot of moving parts but overall the oil price should not be too big a problem for them.”
PEMEX
That’s the good side. However, things look slightly less rosy when one considers the state oil company, Pemex. “It’s nowhere near as bad as Petrobras [the equivalent in Brazil] but Pemex is in bad shape,” says Bakkum.
Fundamentally, Pemex’s whole funding structure is a challenge. The government has said it will give less money to Pemex in an effort to show that its fiscal situation is under control. “That’s bad news for Pemex but for the sovereign it means better fiscal numbers,” says Hardziej.
It’s bad news because the model is that the cashflow Pemex generates goes to the government to finance the budget, but increasingly capex to expand, or even maintain production, has to be financed through debt as the contributions from the government have diminished. “They have the same problem they have had for the last three years,” says Hardziej. “It’s just that it’s got worse.”
In recent years, as leverage has increased from two to four times, the credit metrics have deteriorated since there’s been no increase in production to offset it.
Clearly then, even if Mexico can withstand low oil prices they’re not helpful. “It hasn’t yet been dramatically negative,” says Roberto Lampl, who runs the Latin America fund at Alquity Investment Management. “What will be negative is if oil remains extremely depressed.” Mexico has auctions in July for three major offshore drilling wells; a higher oil price would help to drive interest in them. “Mexico will ultimately be successful but in the near term that could take a little longer,” Lampl says.
COLOMBIA
Colombia should have been badly hit by the oil price — and has been — but is weathering the storm better than might have been expected. Although the country’s total exports as a percentage of the economy are below 20%, less than in Venezuela, Peru or Chile, the problem is that 60% of those exports are oil.
“Colombia has been hit hard for sure in this period of commodity price declines, particularly oil,” says Bakkum. “Like Brazil, all of the excitement about it was linked to the oil sector; when the oil price came down investment growth collapsed as sentiment became weak.” Additionally, oil represents a large part of the Colombian equity market, which has suffered accordingly.
“But I am not worried about Colombia,” Bakkum says. “While it is not a market I would invest in now, it will not fall apart.”
Lampl in particular admires the way Colombia’s government has gone about its business in difficult circumstances. “Here you see a government that is responsible,” he says. “It cuts its budget, raises taxes and was able to grow at 3% last year despite the oil price fall. I’m very positive about the long term prospects of Colombia. There are many strong, well-capitalised companies that are active regionally.”
The ones he highlights are not in the oil sector — instead Argos, the cement company, and Grupo Nutresa, the food business — but nevertheless he does not feel that the oil price impedes opportunities in the country overall. “Right now they are going through setbacks because of the drought that has hit from El Niño and higher than desired headline inflation, but I’m positive for the long term prospects — and the peace process coming through will be great for the development of the country.”
From an investment perspective, Hovasse describes Colombia as “almost a pure oil play in our view and could be a good way to be exposed to rising oil prices, as the country has relatively well run companies.”
Nevertheless, Hardziej thinks the challenges are considerable. “There is a huge current account and fiscal deficit and inflation,” he says. “We are seeing some slow improvements in the current account deficit but we believe it will continue to struggle as its outlook is highly dependent on oil.”
ARGENTINA
Argentina is perhaps the nation with the most going on that has nothing to do with oil. It is affected by commodity prices — and not just hard commodities but softs such as soybean prices, with about 60% of its commodity exports agricultural — but the big story in the country is clearly the process of reform under President Mauricio Macri after many years of Kirchnerism.
“After 14 years of bad policies they now have a government that seems to understand what needs to be done,” says Bakkum. “It’s exciting. There’s a lot of hope. But so much damage has been done in preceding years that they need to find a gradual equilibrium.” He has built a position in Argentina despite the risk. “It is a long time since I was hopeful on Argentina.”
Hovasse is another fund manager ready to reconsider a long-problematic country. “After years of a cautious view on Argentina, we now believe that the country has a good chance to get back on track to become one of the most promising frontier countries over the next few years,” he says. There’s a lot to do, he says, chiefly striking a balance between containing inflation and reducing the fiscal deficit without undermining economic growth. “A lot of progress has been made by Macri’s team,” such as letting the currency float, unwinding capital controls, removing subsidies and advancing negotiations with holdout creditors so as to regain access to the bond markets, “and the probability of an improvement in economic fundamentals and investment climate has increased, in our view.”
Amid all these macro and political influences, are commodity prices relevant? “Commodity prices do play a role,” says Bakkum. “Argentina’s problems are domestic but they are also sensitive to soft commodity prices. If soybean prices went up from here, it would help them a lot for their balance of payments.”
Agricultural commodities have been an early priority of the new government. “We have seen a lot of positive measures from Macri that favour commodity exporters,” says Hardziej, such as reduced taxes and export fees. The picture varies from one commodity to another — there are still taxes or fees for soya whereas they’ve gone for wheat — but particularly factoring in a 55% devaluation in the currency since it was floated in December, “the country has some of the best conditions as an exporter of agricultural commodities.”
On hard commodities too there are possibilities. “It has potential,” says Lampl. “They have one of the largest shale gas reserves, called Vaca Muerta.” (This, regrettably, translates as Dead Cow.) “And it’s more dead than anything right now given oil prices. But Argentina is a net importer of energy, especially of gas, and it should be a net exporter. It has the potential to be so if it is structured properly with the right laws.” How big is the potential? “Argentina could bring in tens of billions of dollars to improve its energy production and export energy to the region.”