Factoring ESG in sovereign credit analysis: recent oil-related issues in Saudi Arabia and Mexico illustrate the challenge of capturing SG

Mexico, Saudi Arabia - Feb 25 2019

Factoring ESG in sovereign credit analysis: recent oil-related issues in Saudi Arabia and Mexico illustrate the challenge of capturing SG

Since 2016, we have proposed unconventional analyses, at least in relation to consensus, of energy issues in international relations and the decisions taken by some key countries, either because of their weight on the international scene or because of the depth of possible repercussions on their national scene. We thus examined the reforms announced in Saudi Arabia and Mexico through a multidisciplinary analysis combining economy, fundamentals of the international oil market, socio-political contexts and historical legacies (see Insights January 2016, October 2017, February 2018, July 2018).

The almost concurrent announcements in the last days of August this year, of the cancellation of the partial IPO of Saudi Aramco in Saudi Arabia and of the questioning of the opening of the Mexican oil domain to international competition, along with a plan of withdrawal from the International Energy Agency, seem once again to have created a shockwave among observers and investors. These decisions, specific to each of these two countries, are nevertheless consistent with our previous analyses and confirm the validity of our approach.

In the Saudi case, the reforming, or so-called ardor of Prince Mohammed bin Salman has just come up against his paternal authority. The King, whose word is scarce, has put an end to a plan to sell part of the national patrimony of oil resources, in continuity and in perfect coherence with the position of his predecessor Abdallah who had already argued in favor of the primacy of the intergenerational link. In the only country in the world whose name is that of a family, one does not joke with what is considered the common good, inalienable by nature. Of course, King Salman wears his age and his health is known to be declining. The paternal figure is not eternal, and a succession will occur in a few years at the latest, that may allow the reactivation of the Saudi Aramco IPO project. But for the time being, the paternal word which restores the founding principle of governance of the country, shall not suffer filial protest and sends a message of unity to the entire population.

As for the Mexican case, the decade of 2010s could give an impression of appeasement on the part of the authorities in their relations with the United States and the international oil industry in general. The initiatives of Presidents Calderon and Peña Nieto, presented as reformers, instead revived in the population one of the founding principles of the Mexican society, namely the management of natural resources in a national and non-competitive framework. The reaction of the population in this regard was a key factor in the unprecedented success of candidate Andres Manuel Lopez Obrador (AMLO) in the last federal election. The plan being prepared by the AMLO team, recently echoed in the press, appears as the programmed closure of the ideological parenthesis opened under the two previous presidential mandates. The AMLO plan restores the primacy given to the national company PEMEX in setting partnerships with other oil companies to exploit domestic resources and, strikingly, envisions the withdrawal of Mexico from the member countries of the International Energy Agency.

From a sovereign risk assessment perspective, the question posed by the Saudi and Mexican cases is that of the consequences of the weight reduction of market principles in the investment decisions of the main economic sector of the country. Firstly, from an analytical point of view of public finances, the two cases appear negative in the short term. However, the total control of the national company offers the possibility of arbitrating the investment decisions depending on the state of the oil price cycle and to reduce the risk of exposure to the natural tendency of the market to feed phases of production overcapacity, resulting in lower prices, lower economic rent and lower asset values.

If the main direction of AMLO's policy is confirmed, the Mexican authorities, who do not intend to give up the development of their domestic hydrocarbon resources, could thus regain control of an important lever for macroeconomic management and monitoring of public finances. Mexico's sovereign risk may turn out to be lower than what the analysis of public finances can conclude on the short term and also lower than that resulting from the continuation of the policy conducted by the Peña Nieto administration. Nevertheless, as the evolution of Venezuela clearly illustrates, the case presented here should be understood as a necessary, not sufficient, condition. The Saudi case is peculiar and escapes this argument in the sense that the country voluntarily maintains overcapacity of production for the purpose of controlling the international oil market. Second, in terms of ESG determinants, our analysis highlights, for both Saudi and Mexican cases, a renewed commitment of national leaders to the founding values specific to each of these countries. We consider that, all other things being equal, these positions help to reduce the risk of social and political tensions, expressed or hidden.

We draw three conclusions from the cases of Mexico and Saudi Arabia, briefly discussed in this Insight. The first, being more general, is that the ESG indicators are meant to be integrated into the economic analysis, not treated as mere extra-financial indicators. The second is that capturing the materiality of SG factors requires a qualitative and quantitative approach and a truly multidisciplinary perspective. The third conclusion deals specifically with the two cases of Mexico and Saudi Arabia. Public information mentioned in this Insight leads us to consider a positive outlook for Mexico and unchanged for Saudi Arabia.

Olivier Rech, Head of Energy-Climate Research
Sources: Reuters, Arabian Oil & Gas

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