PEMEX Reform – The Final Frontier

(via No Se Mancha blog)

This is why the reforms proposed by the Peña Nieto administration are so important. Just putting the words “reform” and “PEMEX” in the same sentence in Mexico is already a type of reform.

Up until recently, the thought was unthinkable.

Today, 75 years after the country nationalized its oil exploration and production by taking control of a host of U.S. and British-owned assets in the country, Mexico is faced with dwindling production numbers, a fall in proven reserves in its showpiece Cantarell field, and increasing demand in its growing industrial economy. Through in an energy renaissance north of the border that threatens its largest export market and suddenly times are ripe for change.

Now, as Mexico builds a framework for opening up foreign participation in the country’s oil industry, politicians, citizens, and hydrocarbon companies are vying to direct reform in Mexico, and, more importantly, who will net the largest share of the reforms.

Uttering the word “PEMEX” to any Mexican is likely to provoke a reaction. Tell a taxi driver and he’ll complain about creeping price rises at the pump. Tell a leftist and risk an hour-long diatribe on the history of imperialism and the Mexican Revolution. Tell an economist and she’ll embark on a long discussion of how over-dependent the state’s finances are on oil resources.

Even the most partisan PEMEX supporter will admit that the country needs foreign oil expertise to unlock more challenging fields through advanced drilling and surveillance techniques. This is why the government and private oil companies from the US and farther afield have changed their often frosty relations over the past several years into a more engaging discussion of how and when, rather than if.

The Felipe Calderón administration (2006-2012) recognized this reality in 2008, when it passed reforms that allowed external companies to assist in new exploration offshore. Because they remain hamstrung on investment possibilities by broader constitutional constraints, they haven’t produced any major upstream operations.

Any glasnost will involve increased foreign participation in exploration, rather than outright privatization. Mexicans across the political spectrum would likely bristle at the possibility of its oil fields in foreign hands. Beyond nationalism, the constitutional reform necessary to divorce the state from Mexico’s oil markets would be a herculean task.

Still, Reform is not inevitable.

Serious roadblocks include citizen opposition, pressure within opposition parties to not hand such a juicy victory to the PRI, and the nitty-gritty fights behind constitutional reform. Another fight that transcends party lines concerns how resources will be distributed in a post-PEMEX federal budget.

Mexico’s public budget relies heavily on oil revenues, and oil royalties from PEMEX in recent years has comprised between 35-50 percent of total spending. This is a vast public policy challenge for Mexico, and over the past several years the government has paid dearly for oil price hedges that guaranteed a price floor per barrel for Mexican oil.

El País published an excellent article this week summing up the challenges ahead for President Peña Nieto:“En las próximas semanas, el Gobierno del PRI deberá concretar su propuesta de modernización de la petrolera más allá de su voluntad de abrirla a la inversión privada y de ambiguas declaraciones sobre la necesidad de modificar la Constitución para que la reforma sea real y no cosmética. Para esto último, el PRI, al no tener mayoría en el Congreso, necesitará los votos del Partido Acción Nacional (PAN, centro derecha) que, de momento, se deja querer y no opone serios obstáculos a la iniciativa.”

In the next few weeks, the PRI government must offer a concrete plan to modernize PEMEX. They will have to transcend vague overtures to “open up the oil company to private investment” or to “make the necessary amendments to the constitution” to drive real reform.

On the point of constitutional reform, given that the PRI does not have a majority in Congress, it will need the votes of former President Calderón’s center-right PAN party. The PAN, for its part, appears open to discussing reform, and has not put any serious obstacles in the way of Peña Nieto’s initiative.

I’m bullish on the prospects of energy reform

…for the same reason that I’m bullish on Mexico. Beyond the macro winds that have shifted in favor of Mexico (including a US recovery and rising labor costs in China), the discussion of oil revenue comes at a time when Mexico’s economy is more diverse than ever. Heavy manufacturing is booming thanks to the US recovery.

A closer North American union and rising labor costs in China have converged to make the Mexico’s tech, textile and light manufacturing industries competitive again. And brisk internal demand for consumer goods and construction materials makes Mexicans less sensitive to the idea that all their energies are focused on exports.

Certainly there are a number of improvements that would make pumping crude even less central to the country’s livelihood, such as investments in refining that would move its exports up the value chain (rather than exporting crude to Texas to be refined).

But this first step towards meaningful foreign participation in Mexico’s oil sector couldn’t come at a better time for the country. Politically, a reform seems much easier to swallow when times are good than when a government is desperate for revenue.

Reform: Easy as one, two, PRI

In a way, the fact that the PRI is spearheading reform in Mexico makes it more credible to Mexicans across the political spectrum.

A party borne of the Mexican Revolution and built around strong national icons, managing state assets in a way that isn’t entirely oligarchic falls within the little moral authority that most Mexicans give them. Add in the recent “Pact for Mexico“, a tripartite pledge to reform Mexico’s fiscal state of affairs, and Peña Nieto can be credited with establishing a credible agenda.

What remains to be seen is who benefits most from the reforms.

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