Focus: Energy Reforms

Well Thought

Well Thought

Jul. 14, 2013

Mexico is the fifth largest non-OPEC oil producer in the world, and in March of 2013 President Peña Nieto announced that proven oil reserves had reached 13.87 billion barrels of oil. It has the forth-largest estimated shale gas reserves of any country at 681 trillion cubic feet, and PEMEX, the government monopoly charged with the extraction and sale of these resources, is one of the largest companies in Latin America at $415.7 billion in assets; only Brazil's Petrobras is bigger. PEMEX provides one-third of the Mexican government's revenue each year through taxes and employs 170,000 people, making it a pillar of the Mexican economic machine and a crucial source of government revenue.

However, Mexico imports half of its petroleum and 40% of its natural gas, all of PEMEX's four divisions except one lose billions of pesos each year, and output fell precipitously starting in 2004, from 3.4 million barrels a day (bbl/d) to 2.6 million bbl/d in 2009, a decrease of some 35%. Although high oil prices in those years helped avert what could have been a catastrophe, PEMEX's last decade in business amounts to a wake up call.

Increased investment in exploration stopped the decline, but did not restore production to previous levels or force any significant new strategies into being. Production at old fields was ramped up, but exciting new prospects have come to light in the deep-water arena that could change Mexico's future and provide strong impetus for reform. PEMEX found three valuable light oil fields in 4Q2012, and it estimates there are 29 billion barrels of oil at deep-water sites. Optimism is high; both the current and former administrations have touted the potential of Mexican deep-water exploration. Felipe Calderón, who was president until 2012, commented that: “The hope [is] that on the Mexican side there are petroleum deposits like the ones already found on the US side." PEMEX has, as defined by Mexican law, “its own legal personality and assets," but 70% of its yearly revenues are taxed by the government. As a result, PEMEX lacks the cash, and the deep-water experience, to take advantage of resources that continue to come to light.

President Peña has turned the nation's focus to its economy, and the energy sector holds the most promise and is the largest challenge. No energy reform bill has been presented yet, but the issues it must deal with are relatively clear. President Peña, the Secretary of Energy, and the head of PEMEX have all stated that the bill will have to find a way to bring foreign investment to Mexico's oil and gas projects. The deep-water potential off Mexico's coast may be enormous, but if PEMEX is to profit from it in the next decade, it must work with foreign expertise. Second, any energy bill will have to restructure PEMEX, which has resisted all attempts at major reform for decades.

Complicating the first goal of allowing foreign participation in Mexico's energy industry is a 1938 amendment to the Mexican Constitution. Instated by the populist and much-loved President Lázaro Cárdenas, the amendment makes all hydrocarbons the property of the Mexican government. It also prohibits production and sharing agreements (PSAs), and foreign private investment in PEMEX. Any partial IPO such as that used at Petrobras is not possible. There is discussion of an amendment to the constitution, but PEMEX has been a source of national pride in Mexico's electoral base for decades, and it remains to be seen if there is political will enough to force significant change. What is clear is that if deep-water prospects are to be explored, PEMEX needs help. It spent $3.8 billion to discover the fields the nation has just become aware of, but that investment would have to see a major and sustained increase from a company that is fighting annual losses for any oil to see the light of day.

Changing PEMEX's structure means tackling its swollen workforce and its financial dependence on the government. The PEMEX union is Mexico's oldest and most powerful, and it is headed by the powerful Carlos Romero Deschamps of the PRI, who is now a senator. Although PEMEX sold $130 billion of crude oil last year, its debt stands at $51.4 billion, nearly 30% higher than in 2008. Part of this is due to the heavy taxes it pays to the Mexican government, but the 170,000 workers at PEMEX are also guaranteed pensions, housing, and collective contract negotiations. Current pension liabilities stand at $52.3 billion, and total contractual obligations at $141 billion, numbers that are formidable even for an organization of PEMEX's size.

Historically, unions have been among the most powerful organizations in the country, and previous administrations have not confronted them because of their sway with voters. However, the President has already made significant progress in tackling the teachers union, and this momentum will help.

While not all Mexicans are convinced of the President's agenda, there is no doubt that the reforms are gaining momentum and the attention of businesspeople and the international community. In an interview with TBY, Gabriela Hernández Cardoso, President & CEO of GE Mexico, clarified an increasingly common sentiment in Mexico: “It is very important to clarify that it is not a discussion about privatizing oil, the discussion is around what business models make sense for the energy mix." Her optimism is echoed by Shell's CEO, Alberto De La Fuente, “The expectation is that energy reforms will take place in the near future, and we will be following the debate and outcome of the discussion very closely." De La Fuente's brevity is incisive, as virtually all players and potential players, domestic and international, will be scrutinizing developments in Mexico.

More encouraging even than the comments of these top players in the Mexican energy market is Fitch's upgrading of Mexico's foreign currency debt rating to an investment grade BBB+ in May of 2013. The agency cited Mexico's “strong macroeconomic fundamentals" and “the greater than anticipated commitment of the new administration and congress to pass structural reforms." This vote of confidence augurs well for the energy reform. For the first time in many years, Mexico's political parties are united in an effort to fix lingering problems, and the new PRI government seems up to the task of leading them to success. It seems certain that Mexico will pass energy reforms in the near future. The only question is what form they will take, and if international investors will be allowed, or willing, to put their money into Mexico's future.

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