ESG Engagement with Petroleos Mexicanos (PEMEX)
At the end of December, I had the opportunity to meet with the management of Petroleos Mexicanos, known as PEMEX, to discuss the outlook for the company, including developments in the company’s plans to manage environmental, social and governance (ESG) risks. J.P. Morgan Asset Management considers financially material ESG factors as important considerations for investors when assessing an investee company’s performance.
Looking at various ESG ratings referenced in the industry, PEMEX tends to rank worse than its Latin American oil and gas company peers, creating reputational risks and uncertainty for certain investors. The country and company have been called out in news stories over controversial amounts of gas flaring1. This is worrisome, as methane flaring is a waste of national resources and likely indicative of planning or operational issues2. The 100% state owned structure and high leverage also create challenges for any governance assessment. Some investors attribute underperformance of PEMEX bonds to these ESG concerns, which represent material operational, regulatory, and reputational risks.
At the same time, PEMEX is a critical part of Mexico’s economy and society, creating a more nuanced picture for the “social” pillar. PEMEX is the dominant energy player in Mexico, and oil related revenues generate 15-20% of total government revenues. The company employs over 100,000 Mexicans and operates schools and hospitals throughout the country. As a local analyst explained during our trip, in some of the regions where PEMEX operates, working for PEMEX is one of the few viable paths to a middle-class lifestyle. Areas with greater investment from PEMEX tend to see a decrease in crime. As investors, we are interested in financially material ESG factors — understanding the social role PEMEX serves is critical to understanding the government’s continued financial support of the company.
We have been engaging with PEMEX over the past several years as part of our standard EM sovereign credit research process, with a focus on managing long-term risks for our clients. There have been challenges in engagement due to the sheer scale of the company, personnel changes, and the need for government support during major transitions. Despite these challenges, we think PEMEX has begun to address some key issues, but a lot of work remains. In particular, on our trip the company’s management highlighted:
Increased ESG disclosure – PEMEX recently increased the availability of ESG related disclosures, which is important for investors to assess long-term risks. This includes updated disclosures on their website, business plan, and quarterly earnings calls on topics including local community impact, employee health and safety, and emissions target setting. The company still has more to do, especially to meet upcoming regulatory requirements, but there has been a marked improvement.
Plans to reduce methane emissions – PEMEX has been criticized for excessive amounts of gas flaring – the practice of burning natural gas associated with oil extraction. This is wasteful as infrastructure investment could allow the gas to be captured and processed for use as energy. Resolving this issue would reduce regulatory and reputational risks, while improving Mexico’s availability of natural gas for productive economic purposes – this would be a win for investors, PEMEX, and Mexico. PEMEX has stated a goal to reach 98% gas use3 by the end of this president’s term (end of 2024), which is a positive step, but it still lags behind international standards of 99%+4. They also partnered with the US EPA to better measure their methane emissions5.
Government Commitments and Impact on PEMEX - the most important changes at PEMEX typically involve the government. At COP 27 last year, Mexico’s foreign minister Marcel Ebrard announced a commitment to reduce national emissions by 35% by 20306. Additionally, one of the leading candidates for the upcoming 2024 election, Claudia Sheinbaum, is a climate scientist looking to bring more green initiatives to the country7. Strong government support will remain critical for many aspects of PEMEX’s future, especially its transition.
I very much appreciated the gracious welcome PEMEX’s management provided during our visit. It is clear the company is very proud of its operations and its role in Mexico. I was heartened to hear top executives understand the need to respond to investors’ focus on financially material ESG risks. I conveyed that investors will be tracking their progress on their pledges.
When it comes to challenging stories, engagement is an important tool to understand the risks and opportunities companies present. We believe our engagement with PEMEX provides important insights that help inform our understanding in the broader context of PEMEX’s bond market presence as the largest EM issuer, and its importance to Mexico and global oil production. We believe that engaging with issuers on financially material ESG issues —and, even more so, with challenging stories—is an important part of our long-term investment strategy.