Energy Reform in Mexico: If It Happens, Will It Really Matter?

Mexico, despite 42 billion barrels of crude oil reserves, is far from the global forefront in technology and development and almost nowhere in the debate on renewable energy alternatives.  Energy policy in Mexico, hobbled by decades of nationalist mythology and political vacillation, is adrift on a sea of oil.  Something is very wrong with this picture.

Pemex has slipped in the ranking of the world’s top oil companies – from sixth in 2000 to eleventh – most notably for its inability to use increasing revenues to achieve growth in operations. Total crude production and crude oil exports (mainly to the US) have been falling steadily beset by declining productivity in Cantarell, Mexico’s largest oil field and by decades of insufficient investment.  (See chart below.)  Pemex revenues have traditionally been siphoned off by a government seemingly unable to collect taxes in any other way.  Instead, the company is saddled with an enormous debt as it struggles to fulfill its mandate to develop oil and gas. 

Pemex’s drilling record is poor, with expenses high and productivity low.  About 29 billion barrels in potential reserves are believed located in the deep waters of the Gulf.  Pemex is operationally and financially incapable of mounting the type of effort needed.    Alone among the world’s state-owned oil companies, Pemex has no risk-sharing agreements with foreign oil companies. 

Limited refining capacity (a legacy also of the constitutional prohibition on private investment in oil) is behind a surge in imports of refined products, mainly from the United States.  Mexico’s subsidies to gasoline and other refined products make matters worse.  Demand for gasoline is rising steadily.  Consumer subsidies in 2008 amount to about $34 billion dollars, primarily to subsidize gasoline prices which are at least one-third less expensive in Mexico than in the US. 

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What Kind of Reform Is On the Table?

It is encouraging at least that Calderon administration in May proposed a measured reform of energy legislation, albeit without touching the draconian restrictions of Article 27 of the constitution.  The PAN proposal would give Pemex greater budget autonomy to invest its earnings and to enter into incentive-based contracts with third parties (which would pay bonuses for success while maintaining state ownership of any oil found).   Importantly, the Calderon proposal would also allow private sector investment in refining, storage, and transportation.  The reform would advance in transparency and corporate governance, particularly by allowing for the election of independent Pemex directors.   

The good news out of Mexico in recent weeks is that the political opposition has not rejected the Calderon initiative out of hand.  In fact, the PRI has come out with an energy proposal of its own which accepts many aspects of the PAN proposal with the important exception of removing the option for private investment in refining, storage, and pipelines. (Through a logic not crystal clear, the PRI prefers that these activities be carried out by new subsidiaries of Pemex, even though Pemex clearly lacks the resources to fund such initiatives.) The PRI also opposes independent directors for Pemex, insisting that these be approved by the congress.

The leftist opposition PRD has not been very helpful.  While some sectors within the party see a need to support energy reform, AMLO and other PRD leaders continue to treat Calderon’s exceedingly modest reform proposals as near treasonous acts.  The party recently organized a nonbinding national referendum in which it claimed that 80% of those voting opposed Calderon’s initiative.  The majority PRD position is that nothing is wrong with Pemex that a more transparent administration and improved efficiency could not address. 

Sorting through all of this, it appears likely that some sort of PAN-PRI alliance (with some support from some PRD legislators) will allow for the passage of a watered-down version of the Calderon proposal by late August or September.  That is the good news – some reform will be agreed upon.  The most significant aspects of the reform would be Pemex’s increased ability to enter into the incentive-based contracts and also the possibility, if it survives PRI opposition, of private investment in refining.

The bad news is that any reform these politicians can agree upon will stop far short of meeting Mexico’s energy challenges.  Worse, the watered-down reform likely to result this year will  forestall the possibility of further reforms during the remaining four years of the Calderon administration because of the rhythms of the electoral cycle in Mexico.   

Is There Another Way?

Two major problems stand in the way of meaningful energy reform in Mexico.  The first is the survival of a nationalist mythology seemingly intact since the 1938 nationalizations and enshrined in Article 27.  The fact that an overwhelming proportion of the Mexican population would favor a change in this anachronistic legacy apparently provides too little cover for fearful politicians who have come of age steeped in this mythology.  None among them has been able or courageous enough to articulate a modern petroleum policy more in line with national interests than one which seems out of tune with the modern world.

The second problem is that the fiscal weakness of the Mexican state makes any reform leading to greater autonomy for Pemex a very tricky proposition.  Despite more than a decade of efforts to diversify the tax base of the Mexican government, more than 40% of federal revenues still comes from taxes on Pemex.  If the funding of general government operations, including the energy subsidies, is so heavily dependent on Pemex oil revenues, it stands to reason that Pemex cannot possibly mount the type of aggressive investment program needed.  This limits the scope of any energy reform.

Could looking at the experience of other countries offer some ways out of the Mexican oil dilemma?  Obviously, many countries have sought to reconcile state ownership of hydrocarbons with an energy policy that makes sense.  Mexico could and should learn from these experiences.

A positive case in point is the transformation of Petrobràs, and of energy policy more broadly, in Brazil over the last fifteen years.  As was the case with Pemex, Petrobràs was also born in a moment of intense nationalism and over many years became a powerful symbol of state control of natural resources.  At the same time, the company was contributing little to relieve Brazil’s longstanding dependence on foreign oil.  It is a long story, of course, but Brazilian politicians eventually figured out a way to preserve the essence of state control in oil while focusing on energy needs more broadly and turning Petrobràs into the efficient and competitive force in the global oil industry that it is today. 

Mexican politicians and the debate in Mexico often treat Pemex as a totally unique case of a state-owned oil company.  As much as that sort of approach may suit the politicians, the time for insular thinking on energy policy has long since come and gone.   When Mexico goes looking for positive role models, Brazil may be a good place to start.