What's Behind Pemex's Play for Repsol?

Efforts by Pemex, Mexico’s state oil company, and Sacyr Vallehermoso, the Spanish construction company, to take control of Repsol --one of the world's largest private-sector oil firms and the largest energy firm in Latin America -- suffered a serious setback with the firing of Luis Del Rivero as president of Sacyr Vallehermoso. In the absence of support from Del Rivero, the strategy pursued by Pemex and Sacyr is in jeopardy. The controversy raises other questions -- What is Pemex trying to achieve with the deal? And where does the firm go from here?

Talk about the company's future strategy first arose two months ago, when Pemex increased its stake in Repsol from 4.8% to almost 10%, and sealed a pact with shareholders of Sacyr, which owns 20% of Repsol, to join forces on the energy firm’s board of directors and at its shareholder meeting.

The agreement was a bombshell, adding more fuel to the firestorm facingAntonio Brufau, Repsol’s president, who has been struggling against Sacyr, Repsol’s largest shareholder, for the past five years.Sacyr’s shareholders ousted Del Rivero, president of that company, because of his alliance with Pemex. Del Rivero’s differences with both Demetrius Carceller and Juan Abelló, the new top executives of Sacyr, were in part due to how Del Rivero wasmanaging Sacyr’s 20% stake in Repsol.

Del Rivero’s demise puts Sacyr’s partnership with Pemex in jeopardy. In addition, Pemex’s move to take control of Repsol is now up in the air, threatened by the possibility that Sacyr could break the pact or substantially modify it.Both Carceller and Abellóhave said they are  against using the alliance with Pemex to take control of Repsol. Instead, the two have advocated a more diplomatic route. One possible reason, is that “it is not normal for a small [company] to consume a larger one,” says Esteban Garcia Canal, a professor of business management at the University of Oviedo.

At the core of the battle within the construction company that led to Del Rivero’s dismissal wereSacyr Vallehermoso’s financial problems, and the serious challenge Sacyrfaces when it comes to repaying a loan of about five billion euros that the firm acquired when it bought a 20% stake in Repsol. The loan needs to be refinanced before the end of this year.Del Rivero consistently defended keeping the company's ownership in Repsol intact, and insisted on requiring Repsol to raise its dividend to pay off the loan. However, that would require selling assets of the energy company.Sacyr’s new leadership favors divesting a portion of its share in Repsol in order to lighten the construction firm's financial burden.

If Abelló and Carceller choose to carry out that sort of move, they could unseat Pemex from the position of control in Repsol that it had achieved by partnering with Sacyr. The alliance between Pemex and Sacyr gave the two control over 29.9% of the capital of Repsol, compared with the12.8% controlled by CaixaBank, the Catalonian financial institution.Despite the divergence since Del Rivero's ousting, power is actually now more evenly balanced on Repsol’s board of directors precisely because Abelló never bowed to the wishes of Del Rivero, although both represented the interests of Sacyr’s highest administrative group.

With the fall from grace of both Del Rivero the balance of power within Repsol is now tilted toward the side opposed to a grab for power by Pemex. Pemex's investment to strengthen its ownership in Repsol was widely questioned in Mexico. Last October, Juan José SuárezCoppel, Pemex’s director general, appeared before Mexico’s Chamber of Deputies, where he was asked to explain, among other things, how Pemex was able to make foreign purchases and acquisitions when it has delayed projects within Mexico.

Pemex's Power Play

What exactly does Pemex want from Repsol? Internal company documents obtained by Spanish newspaperEl Paísin late September showed that Pemex wanted to take over Repsol at a bargain price, especially compared with the multibillion-dollar investment that Pemex would have needed to make in order to achieve a similar position in any oil company of similar prominence to Repsol.

More specifically, Pemex estimated that it would have cost between "$10 billion and $30 billion dollars" if the firm had wanted to "exercise sufficient influence to have an impact on strategic decisions in any oil company comparable to Repsol." Such an alliance would have allowed Pemex to access the technology of Repsol in all matters related to deep water exploration, and even to direct the flow of the oil that Repsol supplied to Pemex’s own refineries.According toEl País, Pemex also hopes to take advantage of the differential in gasoline prices between Europe and the Gulf of Mexico, through strategies of supply and long-term contracts.

Achieving any of these goals wouldbe possible only if Pemex had greater power on the Repsol board of directors, since that's where Repsol's strategy is formed. "Pemex is interested in having more influence on [Repsol’s]highest administrative organ. Its battle is not aboutraising the dividend, which is whatSacyr is thinking about, but about acquiring more influence. By allying itself with [Sacyr], Pemex gets such a large amount of [Repsol's] capital that is harder to keep them quiet," notes Joaquin Garralda, an expert in strategic management at IE Business School in Spain.

The first offensive launched by Pemex and Sacyr after sealing their alliance was to ask for more members to be added to the Repsol board so as todilute the influence of the current Chairman, Antonio Brufau, while creating the position of chief executive. However, Repsol’s top leadership vetoed those requests. Instead, theywereable to block Pemex by enacting new regulations against any conflicts of interest that couldarise with companies that are Repsol's competitors. Thisdart was targeted directly at the chief executive of Pemex.

For three decades, Mexicohas been a quiet shareholder in Repsol, and its participation was always viewed as harmless and financial in nature. This long tradition could have made it appear logical that, at any moment, the two companies would tighten their relationship further. But Pemex's moves wound up souring its relationship with Repsol.

"When it comes to analyzing the objectives of Pemex in its alliance with Sacyr, there are two problems. First of all, there isthe issue of international expansion," Garcia-Canal says. "It is perfectly understandable that Mexico has a strategy aimed at growing internationally along with the Spanish firm. The other issue is corporate governance, since it is Sacyr, the largest shareholder in Repsol, that allied with Pemex; it is not Repsol who seeks out an alliance with Pemex.”

Crossing Borders

Repsol's strong position in Latin America, particularly in Brazil, is an asset that any oil company in the world might envy -- and Pemex is no exception. On the contrary, Pemex might even have more interest in Repsol than other groups would have, since having a larger role in Repsol would allow Pemex to break down the borders between North and South America in order to exercise more power in several countries on the subcontinent.Indeed, Garralda notes that, ultimately, Pemex’s alliance with Sacyr is "a move aimed atinfluencing the international oil business. Repsol offers [Pemex] a lot of power in such countries as Argentina, Bolivia, Argentina and Brazil."

"Eight-five to ninety percent of petroleum rights around the globe are in the hands of countries and their governments, who dole out exploration rights to the oil companies. By allying itself with Sacyr, Pemex is attemptingto use Repsol so it can gain political power in the region, and then use [Repsol] to defend its own interests," Garralda adds.

Although Del Rivero’s departure struck a blow against the interests of Pemex, the Mexican oil firm still has a window of opportunity to keep its alliance with Sacyr afloat. This could happen if Pemex were tobuy a portionof Sacyr’s stake in Repsol. Brufau, Repsol's president, offered that option to Pemex last summer, according to business news daily Expansion. A move alongthose lines would bury the hatchet between Repsol and Pemex and turn Pemex’s perceived betrayal of Repsol into a gesture of friendship.

In addition, such a move would permit Sacyr’s new nucleus of leaders to meet its goal of reducing the company’s debt. The new president of the construction firm, Manuel Manrique, has already sat down with Brufau to discuss the foundations of the new relationship between the two companies.

Knowledge@Wharton