Private Investment in Mexico is Booming. Are Investors Mispricing Risk?

Private capital is playing a big role in helping Mexico build up the infrastructure necessary to meet its growth

At the time when many emerging markets are struggling to attract international capital, Mexico is expecting major investments in its transportation, water services and energy sectors, say market observers.

“There is a great amount of interest from both local and international investors,” says Jose Valera, a partner at law firm Mayer Brown and co-head of the firm’s oil and gas practice. “Mexico belongs to the [lower-risk] Chile, Peru and Colombia bucket. The government is strongly committed to seeing this reform through.”

Some institutional investors are less sanguine, however.

“Because of all the interest, the returns are moving to the levels of developed countries,” says Carlos Isorna, VP at Macquarie Mexican Infrastructure Fund. “Some projects will receive revenues in dollars, but a dollar invested in Mexico may not have the same risk as a dollar invested in the U.S., and the question becomes whether the investors are paying a fair price to enter the country.”

Oil Shock, But Stable Growth

Even though the performance of the Mexican economy has been affected by lower oil revenue, the country has maintained moderate growth thanks to an expanding services sector and growing private spending, according to a June presentation from the Mexican Central Bank (Banxico). According to data from the World Economic Forum and the International Monetary Fund, the Mexican economy will grow 2.5 percent this year and 2.6 percent in 2017.

By contrast, Latin America and the Caribbean combined are projected to shrink 0.4 percent this year, and accelerate only 1.6 percent in 2017.

Declining tax revenue from oil has limited public resources and forced the government to increasingly rely on private sector investments to implement its ambitious reform agenda. For example, in April, the Secretariat of Communications and Transport announced it would be seeking private investment to complete the $3.1B expansion of the Veracruz port. The public participation is expected to be only around 22 percent, or $682B, down from 40 percent anticipated previously, according to press reports.

While private investment is important across various sectors, it is particularly crucial for Mexico’s flagship company, Petroleos Mexicanos (Pemex), which is facing liquidity problems after $5.3B budget cut announced in February.

In particular, Pemex’s exploration and production division is being hit hard by the budget cut. Even before the budget adjustment, the company lacked the resources and technical capacity to invest in the division, according to a presentation from Ainda Energía & Infraestructura. Ainda is raising a $1B fund that will focus on investments in underperforming greenfield and brownfield assets in upstream oil and gas, as well as transportation and water assets. The fund is expected to close in the second half of 2016.

Some investors may be wary of partnering with Pemex, says Horacio De Uriarte-Flores, partner at Mijares Angoitia Cortes y Fuentes. The company’s shaky liquidity position has recently been propped up with lines of credit from the Mexican development banks, as well as a capital injection from the Ministry of Finance and Public Credit. Last year, the company extended the payment terms for suppliers to 180 days.

The spread between the Mexican government and the company bonds has also widened, says Marisol Gonzalez de Cosio, Director at the Energy and Infrastructure group at Kroll Bond Rating Agency.

These issues have failed to deter major institutional investors from working with a company that, after all, still holds 83 percent of Mexico’s proven and probable reserves. Some notable recent developments:

• • In March of last year, First Reserve and BlackRock acquired a 45 percent interest in one of the largest energy projects in Mexico’s history—a $2.3B pipeline project in Los Ramones.
• • In June, Pemex said it would carry out a bidding process for the company’s first exploration and extraction partnership to develop the Trion field in the Gulf of Mexico, the country’s first deepwater field.
• • KKR has completed a $1.2B sale-leaseback transaction with Pemex that includes pipelines, subsea cables and two non-drilling platforms, according to Thomson Reuters. KKR declined comment.
• • Last month the government launched the second round of oil auctions, offering 15 E&P contracts in the shallow waters in the Gulf of Mexico. With the bids due in March 2017, the auction is set to attract $60B of investments into the country.
• • In July, Macquarie Mexican Infrastructure Fund closed the $41M acquisition of a 22.5 mw solar park in the state of Coahuila. When completed, the park will provide energy under the self-supply scheme to administrative buildings and schools in the municipalities of Matamoros and Torreon.

Projects galore

This investment activity may only be the beginning, given Mexico’s woeful lack of infrastructure. With regard to midstream assets, for example, Mexico has only one-tenth the of gas pipeline infrastructure of the U.S., according to Ainda.

The country’s Comisión Federal de Electricidad has already awarded 15 privately financed pipelines and has seven left. In the fall, the country expects to award a $7B contract to bring Internet, cell phone and landline service to 98 percent of the population.

In April, Mexico held its first electricity auction that is anticipated to attract an investment of more than $2.5B and result in 18 wind and solar projects. The winners of the auction are mostly utility companies that in some cases have financial sponsors, such as money manager GBM Infraestructura, which also is building two wind parks on the Yucatan peninsula in consortium with Spanish conglomerate Grupo Aldesa.

In transportation, the country is building a new international airport in Mexico City. The new airport will have capacity of 125 million passengers per year—four times greater than the current’s airport capacity. The project will require an investment of close to $11B. It is set to start operations in October 2020.