How to Invest in the Opening of Mexico's Oil Market

The Mexican Senate has finally signed off on a bill that will end almost 80 years of state monopoly on oil production. Which stocks are the most likely to get in on this new market?

Jason Ditz
Jason Ditz
Jul 22, 2014 at 5:20PM
Energy, Materials, and Utilities

Mexico is finally open for business for oil investors. This past weekend, the Mexican Senate finally gave its approval for a law which will end the monopoly of state-run Pemex and open up the market to private and foreign competition.

While it's still early goings here, today we'll take a look at five different companies that are likely to be in the mix for new business from this significant reform, which ends almost 80 years of monopoly, and which Mexican legislators are hoping will stop the giant losses Pemex is reporting annually.

The why of reform: a look back
In March of 1938, President Lazaro Cardenas sought to solve years of union woes with private oil companies, chiefly Royal Dutch Shell (NYSE: RDS-A) and Standard Oil's remnants, by nationalizing their assets and founding Pemex as a state-run monopoly.

Since that time, Pemex has become a primary source of revenue for the Mexican government, but extensive taxation and a lack of foreign capital has energy production on the decline, and profits along with them. In FY2013 Pemex reported a $13 billion loss, and another $2.74 billion was lost in the first quarter of 2014.

The hope is that the influx of new capital will revitalize the industry, improve the economy, and allow Mexico to scale back on their reliance on Pemex taxation to fund day-to-day operations of the government.

Running back in
It's been 75+ years, but expect Royal Dutch Shell to be among the first companies to charge back into Mexico, along with Chevron (NYSE:CVX) and ExxonMobil (NYSE:XOM), exactly the sort of companies with the deep pockets and expertise to get the existing Mexican oil infrastructure back up to international standards.

But why stop there? These guys are going to be the big players in Mexico's existing production, but don't forget about vast untapped reserves, like offshore deepwater reserves in the Gulf of Mexico, or the enormous shale formations, which Pemex said are worth an estimated $2.2 trillion alone. Who's in play there?

Expect Transocean (NYSE:RIG), as one of the world's dominant deepwater drillers with multiple operations in the Gulf of Mexico, mostly contracted out to the aforementioned Chevron, to get in on that offshore wealth, while EOG Resources (NYSE:EOG), a big player in Texas' lucrative shale industry, would be a prime candidate to expand southward into Mexico's untapped shale reserves.

Considering how much of Mexico's oil wealth has remained virtually untapped since 1938, as Pemex went for the easy stuff, it makes sense for everybody to be pushing to get in on this new openness, though the most experienced and biggest of them are doubtless at an advantage. This is particularly true of Transocean, which owns around half of the world's deepwater platforms.

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Five companies by the numbers
Royal Dutch Shell, ExxonMobil, and Chevron are the easiest three companies to do apples-to-apples comparisons with, so we'll start there. Royal Dutch Shell sports the highest dividend of the three, at 4.7%, which makes it a favorite among income investors.

Beyond Royal Dutch Shell's dividend, Chevron comes in second at 3.2%, and ExxonMobil again close behind at 2.7%. ExxonMobil sports the best return on equity at 18.57%, but it comes at much more expensive valuations. 

Bottom line
Among the three straightforward players mentioned above, Chevron is my favorite, trading at a reasonable price with a sensible balance sheet and good margins all around. ExxonMobil is similar, though slightly more expensive by most metrics, and Royal Dutch Shell, despite the superior dividend, has such low margins that it is concerning.

EOG Resources has a lot of growth potential, but like ExxonMobil it feels more expensive than the alternatives here. Transocean, on the other hand, trades at such a bargain level, pays such a choice dividend, and has a position as a market leader that virtually guarantees it to be in the mix for any deepwater drilling that takes place in the area.

Mexico is definitely doing the right thing in opening up its oil market, and investors would be wise to keep an eye on the companies involved, as there is substantial value to be unlocked here, a potential game-changer for even big companies.