For the first time in 75 years, Mexico stands on the brink of widespread energy reform. The most notable and controversial development revolves around the proposed amendments to Petróleos Mexicanos, otherwise known as the national institution and state owned oil monopoly Pemex. Founded in 1938 when President Lázaro Cárdenas seized the Mexican oil industry from British and American companies, Pemex’s place in Mexico’s economy and psyche is sacrosanct. Yet incumbent President Enrique Peña Nieto has announced that he intends to alter the Mexican constitution in order to reinvigorate the nation’s oil and gas industry whilst simultaneously revolutionising Pemex. Indeed, the government believes that the ambitious gas and oil reforms announced by President Nieto are so important to the future prosperity of the country that they have been recognised as the number one priority in the Pact for Mexico’s modernisation scheme.
Despite Pemex’s ubiquity in Mexican culture, the company is in desperate need of reform. Although Pemex is the world’s 10th largest oil producer, with revenues over $127bn, it is heavily laden with issues. Being a state owned company, it is something of a behemoth; the company employs over 160,000 people and has huge, onerous pension obligations equivalent to 8 percent of the country’s GDP. Furthermore, Mexican oil production has been in state of rather drastic decline since at least 2004. Years of underinvestment from Pemex, ageing, decaying oilfields and diminishing returns have seen production fall by over 25 percent in the last 10 years. Pemex’s refining capacity has also remained flat since 2007. According to documentation filed by Pemex with the US Securities and Exchange Commission, the company’s crude oil production in the first half of 2013 also declined by nearly 5 percent.
In light of its domestic travails, the company has already had to increase its fuel imports to meet the demands of Mexico’s rapidly expanding economy. According to some estimates, if Mexico does not do something to arrest the decline of its oil production, it is possible that the country could become a net oil importer by 2020. For a country with an estimated 13.87 billion barrels of proven reserves – the third highest total in Latin America behind Venezuela and Brazil – this would be tantamount to a disaster.
Further to its declining production levels and profits, the company is beset by a number of other issues in desperate need of resolution. Currently Pemex’s only profit generating unit is its crude extraction division, since its petrochemical and refinery businesses both generate substantial losses. The company also suffers from widespread corruption, unfunded pension liabilities and myriad safety issues. Rather than attempting to reform the company from within, which would undoubtedly be troublesome and prohibitively costly, Mr Nieto’s government proposes to revolutionise Pemex via external, albeit controversial means.
The regeneration of the country’s energy sector is vital to unlocking future competitiveness for Mexico. The nation is rich in hydrocarbons but lacks the requisite resources to develop those assets, hence the increased reliance on oil imports. The amount of gas imported into Mexico has also increased in recent years, rising from just 3 percent of the country’s consumption in 2004 to 33 percent today. In light of these figures, and given the desperate state of Pemex itself, it is clear that drastic action is required to turn the company around. Out of this need was born President Nieto’s program of reforms. However, the energy sector is not alone in feeling the impact. In his first year in office, Mr Nieto has also attempted to reform a number of strata of Mexican society and business, including such diverse areas as the labour market, the telecoms and financial sectors and the country’s tax system. Despite these efforts, reform of the energy sector is arguably the most important.
The reforms serve as a cornerstone of the wider economic program that President Nieto hopes will boost long-lagging growth in Latin America’s second largest economy. Under the terms of the reforms, for the first time private investors will be permitted to drill for Mexico’s oil. Although the reforms stop short of offering private investors full-blown concessions, the changes to the country’s energy sector do go much further than many analysts and supporters of Pemex had expected. The new energy bill represents a major step forward from the service contracts now on offer, in which companies are paid a fee and can recover costs. Furthermore, the bill goes well beyond the original proposal made by President Nieto in August 2013.
Although the reforms proposed by the Mexican President do not go as far as similar reforms carried in other Latin American countries such as Colombia, they have proved to be deeply unpopular with many citizens and politicians alike. In Colombia the government opted to semi privatise and publicly list its national oil company Ecopetrol SA. President Nieto, however, is simply proposing a number of changes that would make it significantly easier for Pemex to broker deals with private, often foreign, companies.
The reform bill also proposes creating a sovereign oil fund that will be managed and overseen by the central bank. The fund will be responsible for managing any savings derived from oil proceeds, as well as opening up electricity generation.
The proposed reforms represent a significant milestone in the history of not only the energy sector in Mexico, but also the country itself. Mr Nieto’s government has forecast that the new energy initiative will attract investment and spur production that will boost Mexico’s annual GDP growth by 1 percent by 2018. The Finance Ministry projected that in 2013 the economy will have expanded by 1.3 percent, down from 3.9 percent in each of the two preceding years. If those figures prove to be correct, 2013 will have seen Mexico’s GDP grow by the smallest amount since the global recession.
However, although the potential liberalisation of Mexico’s oil and gas market promises to increase oil production by a million barrels a day, creating thousands of new jobs and reducing energy bills nationwide, the initiative has been met with staunch, fierce resistance from some quarters. The sovereign status of Pemex is a source of great pride among Mexicans, protected as it has been from private investment by the Mexican constitution for 75 years.
In December 2013, tens of thousands of people protested in the centre of Mexico City against President Nieto’s planned overhaul of the sector and there were protests and scuffles in the Mexican senate building itself. As a result of the proposed changes to the sector, the President’s approval ratings have dropped to their lowest since he took the position in 2012. An opinion poll taken in November 2013 suggested that the President’s approval rating had fallen to 44 percent, 8 percentage points lower than in July. Forty-eight percent of respondents noted their disapproval of his administration. In October, more than 12,500 people poured onto the streets of Mexico City to demonstrate against what they felt was a misappropriation of the country’s assets.
Despite the high level of civil and political unrest surrounding the reforms, the opportunities for foreign firms may well be legion. Pemex currently lacks the financial resources and technical expertise to reverse the downward trajectory it seems to be on. Only by partnering with private investors will Pemex and Mexico be able to fully realise the potential of the country’s vast deposits of gas and oil. Pemex has estimated that investment in its oil and gas fields must top $60bn a year, more than double the current level of investment. Yet despite the influx of foreign capital, importantly the resources being mined would still belong to Mexico under the new energy reforms. The President has been at pains to point out that the reforms do not constitute privatisation – rather, licences will be offered as part of a wider profit sharing scheme.
The controversial constitutional reform would remove hydrocarbons, petrochemcials, electric power and refining from the so called ‘strategic’ sectors that are currently considered the reserve of the state exclusively. By re-classifying these products and techniques the government opens up the possibility of entering into profit sharing agreements with private companies that have expertise in the exploration and exploitation of energy reserves, as well as the much needed capital to finance such work. Crucially, by engaging with large, foreign organisations Pemex can begin to explore the possibility of dealing with prohibitively expensive oil and gas drilling schemes in the Gulf of Mexico. By exploiting the Gulf of Mexico region, the possibility of Mexico sharing in the global shale gas revolution could also become a reality. A number of leading geologists believe Mexico is currently sitting on the world’s fourth-largest reserves of shale gas.
The oil and gas industry’s largest players – companies such as ExxonMobil, PetroChina, Royal Dutch Shell and Statoil – all stand to benefit handsomely from a reformed Mexican energy sector. Similar structures are at work in countries such as Brazil and Norway, which operate state owned companies that work in tandem with foreign organisations to fully exploit local reserves. The licence system proposed under Mexico’s new bill has proven to be both popular and successful in other markets.
Although major players in the energy sectors may be concerned by the inability to ringfence state owned reserves as their own, it is unlikely to stop many of them from entering into profit sharing schemes with Pemex. Some private companies already do significant levels of business with Pemex, including Grupo Carso, which recently signed a $415m agreement to lease a drilling platform to Pemex. Others will undoubtedly be watching as the energy reforms become a reality over the coming years.
By embracing energy reforms Pemex itself could be more active in new international markets. Presently it only has a joint venture with Shell in Houston, Texas and another with Repsol in Spain. In the future, Pemex may begin to look at refining capacities in many locations throughout the US, Europe and Asia. Clearly, energy reforms will lead to a number of excellent opportunities for foreign companies looking to gain a foothold in Mexico. At the same time, Pemex, and the Mexican economy, will gain much from a liberalised energy sector.
The energy bill is just one aspect of President Nieto’s ambitious program of reforms, which also target the country’s education system, tax system and telecommunications sector. The energy reforms, however, stand to be the most transformative and historically significant of all. Moreover, the energy reforms will serve to reinvigorate the Mexican economy. Although the new bill has met fierce opposition, and will continue to do so over the coming months, the reforms set forth by Mr Nieto offer Pemex and Mexico the greatest possible chance at prosperity and economic independence. It is up to Pemex to seize that opportunity as soon as possible.
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