Mexican president Andres Manuel Lopez Obrador took office in December vowing to revive state-owned energy company Pemex and put the brakes on foreign investment to give the public a bigger cut of the country's oil wealth.
The leftist oil nationalist's ambitions include building a new $8 billion refinery, refurbishing existing refineries and reversing a steady decline in crude production.
The problem is that such expensive plans - for the world's most indebted oil company - have alarmed credit rating agencies, which are threatening to downgrade Pemex bonds to "junk" status.
A downgrade could cripple the president's bold energy agenda, along with his plans to use new oil revenue to help finance social welfare programs. It could also imperil Mexico's sovereign creditworthiness.
With $106 billion in financial debt, Pemex would likely see borrowing costs soar as many investors dump its bonds. After Brazilian state oil firm Petrobras had $41 billion of its bonds classified as junk in 2015, its financing costs jumped from $1.6 billion to $8.8 billion in one year.
Mexico's options are limited. Avoiding a debt downgrade would require slashing Pemex's tax bill, forming more partnerships with private firms to develop oil and gas fields, and canceling the new refinery, according to Reuters interviews with investors from a dozen of the world's largest asset managers, along with former Pemex executives and finance ministry officials.
On Monday, the government unveiled measures to lighten the company's load, including a gradual tax cut, $2.5 billion in debt refinancing, and the extension of an existing line of credit with three banks.
The announcement, trumpeted by Lopez Obrador and other top officials, did little to convince doubters.
"There are still big question marks over the long-term viability of Pemex's business plan," said Aaron Gifford, an emerging market analyst with asset manager T. Rowe Price Associates, a major holder of Pemex bonds.
Lopez Obrador's election halted a liberalization of the energy market that had for the first time given foreign and private oil firms the right to develop fields on their own and in joint ventures with Pemex.
Last week, the president announced Pemex would build the new refinery - planned for his home state of Tabasco - because private-sector contractors could not meet his proposed budget or three-year timeline.
Rating agency Moody's on Monday attacked the refinery decision, saying it would probably take longer and could cost 50% more than planned.
"The consequences for Mexico's credit profile will depend in part on whether it continues to undermine market confidence, further dampening already depressed investment and weighing on Mexico's economic prospects," Moody's said in a statement.
The government intends to start building the refinery next month and finish by May 2022. Lopez Obrador also wants to overhaul the firm's six existing refineries, which are accident-prone, operate at 40% capacity and have hemorrhaged money for years.
Some industry experts say Pemex's finances will not support the president's plans.
The new refinery will have to be canceled to avoid a downgrade, said one former Pemex executive, speaking on condition of anonymity and echoing the views of others. Another former Pemex executive told Reuters the state-owned firm should be trying to raise more money by partnering "like crazy" with private oil companies.
Lopez Obrador has generally been skeptical of private energy investment - especially from foreign firms - even while promising to expand Pemex's production and refining capacity. He contends he can save the company money through a crackdown on corruption and fuel theft, and raise output by tapping fields with easily recoverable oil.
Some cabinet members, however, have acknowledged that Mexico could use outside investment to help revive its oil production.
"The government can't do it alone," Energy Minister Rocio Nahle told a gathering of mostly international oil executives in an April 30 speech.
Still, Nahle urged rating agencies to be "responsible" in evaluating Pemex's debt. She argued the firm is meeting its obligations despite picking up the tab for what she characterized as previous mismanagement.
Pemex's financial debt surged by 75 percent under the last government, and the company's total obligations, including pensions, today exceed its assets by more than $70 billion.
Nahle said Pemex had started turning around operations and stopped taking on more debt under the new government.
"We're investing in production and exploration; and we're investing to produce more gasoline and added value," she said.
'Chain of horrors'
Critics of Lopez Obrador's plans, such as Juan Carlos Romero Hicks - a leader of the opposition center-right National Action Party in Congress - say he should have stayed on the path set by former president Enrique Pena Nieto and continued opening up energy development to private capital.
Instead, Lopez Obrador has piled new risks onto Pemex, Romero Hicks said.
"It's a chain of horrors, and horrors that make a mess of public finances in a strategic industry," he said.
Rating agencies Fitch and Standard & Poor's have this year cut Pemex's standalone assessment and put it on negative outlook, inching the firm closer to a financial cliff. Fitch now rates Pemex's long-term foreign debt at BBB-, while Moody's puts it at Baa3 - both one level above a junk rating.
Standard & Poor's said on March 1 that Mexico faced a one-in-three chance of a sovereign debt rating downgrade within 12 months, identifying Pemex as a key risk factor.
If two of the three main agencies classify Pemex as "junk", bond holders whose investment criteria prohibits carrying such assets would be forced to sell. A research note published in February by investment bank JPMorgan estimated that $16 billion of Pemex's $83 billion in bonds would have to be dumped in such an event.
That would make the company the world's biggest so-called "fallen angel" - the ignominious distinction for a borrower that descends from investment grade to junk.
Crippling Tax Bill
A key factor in Pemex's financial weakness is its heavy tax burden, averaging more than 80% of its earnings before interest, tax, depreciation and amortization.
Ratings agencies say the company's financial position will deteriorate if the burden remains so high.
Lopez Obrador in February gave Pemex a nearly $4 billion one-off cash injection, after an additional $3.4 billion for the company's 2019 capital budget, raising it to $14 billion.
Juan Carlos Zepeda, a former head of Mexico's oil regulator, said Pemex needs far more - about $20 billion annually for exploration and production - to reach Lopez Obrador's goal of raising crude output some 50% to 2.5 million barrels per day by 2024.
The president said Monday that Pemex's tax bill would drop by 30 billion pesos ($1.56 billion), without giving a time frame for the reduction. The company paid the equivalent of $27 billion in taxes last year. A bigger cut to Pemex's tax bill would blow a hole in the federal budget - about 15% of which comes from the oil firm.
The government is also considering raiding a budget stabilization fund - intended for emergencies - to help prop up the oil firm's finances, which has never been done before.
But that would provide only a short-term fix in the absence of substantial tax breaks, said Dorthe Nielsen, an emerging market debt fund manager with GAM Investments, which until recently held Pemex bonds.
"This is just pushing out the problem until next year," she added.
($1=19.1880 Mexican pesos)