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Tuesday, June 26, 2012

Energy sector reform poses a conundrum for the next Mexican government

• Will reforms be blocked by the left or watered down too heavily by Mexican tendency to consensus?
• How badly would no reform or a watered-down one hurt Mexico? Declining oil production likely means the country needs to take quick action to alter its tax base, which is heavily dependent on petroleum
• Will reforms be based too heavily on the Brazilian model, when Mexico may need its own model?
• Could the natural gas boom that is spurring a "North American energy revolution" be a savior for Mexico's energy sector?
• If oil prices fall, how much would Mexican economy be damaged?

contenido coverBy David Gaddis Smith

The front runner for Sunday's Mexico's presidential election, Enrique Peña Nieto, recently told Contenido magazine that his top three priorities if elected would be energy reform, fiscal reform and labor reform. He sees them as key to driving the Mexican economy and providing more jobs and lower prices for the Mexican people.

National Action Party candidate Josefina Vázquez Mota and New Alliance Party candidate Gabriel Quadri, like Peña Nieto, also are talking about an energy reform that would see more private investment in the country's oil sector. All have cited the success Brazil's Petrobras state-owned oil company has had with private investment. Petrobras is far more efficient than Mexico's state-run Pemex.

At a recent discussion at the Institute of the Americas in San Diego on the Mexican election Jeremy Martin that focused on energy matters, institute energy program director Jeremy Martin said it is a huge change for top Mexican politicians to be discussing energy reforms more openly. Opening of the petroleum sector to private investment has mostly been a taboo subject since President Lázaro Cárdenas nationalized the nation's petroleum resources in 1938. Even leftist politicians generally opposed to private investment in Pemex have their own proposals for energy sector reform, Martin said.

In part, the discussion is now on the table because it has to be. Martin said some experts are predicting that Mexican production, which has been in decline, could fall to the point that Mexico could become an oil importer in 2020.

That scenario means that fiscal reform needs to go hand in hand with energy reform, Martin said. He said more than 30% of government income comes from Pemex. But if production continues to decline, it no longer will be able to be such a cash cow. Martin said Pemex pays $63.5 billion in taxes, nearly six times what the top 100 companies on Mexican stock exchange did combined. The high taxes Pemex pays means that Pemex is starved for cash for new projects and basically needs investment from outside to grow. The government will have to start collecting more taxes elsewhere in a country where tax evasion is rampant. "Mexico has lowest tax revenue as a percentage of GDP of all OECD countries," Martin said.

Can reforms be passed, and in a timely manner?
The next question is, can Peña Nieto get energy reform accomplished where President Ernesto Zedillo, President Vicente Fox and President Felipe Calderón could not?

Jeffrey DavidowJeffrey Davidow, a former U.S. ambassador to Mexico, said at the discussion: "Let us say that Peña Nieto wins and that he has a lot of strength in Congress, and that the PAN, if it is serious, goes along with Peña Nieto."

Davidow said he thought Peña Nieto would have to move fairly quickly on the matter, which likely would involve constitutional change, and "may need a dynamic, aggressive, well-thought-out plan."

Davidow said the success of the reform might depend on how the left reacts, which may depend on how close the election is. "Should (Andrés Manuel) López Obrador lose ... how is he going to respond? And are we going to have to go through a period of street demonstrations, and public contention and maybe violence for a period of months as we did six years ago? If that is the case, that certainly would make it much more difficult for a new Peña Nieto government to move rapidly on opening the oil sector."

Davidow said the climate that comes out of the election might be toxic as a result of hatred of the PRI, making change difficult, even though he said the PRI is no longer the autocratic party it used to be. "This is not the same PRI that existed a dozen or twenty years ago.... It's not your father's PRI," said Davidow, who also said Mexico's presidency no longer is able to impose its will on governors as it did in the past.

Davidow also said Mexico's nascent student movement, which might in normal circumstances be open to change in the energy sector, seems so distrustful of government and the PRI that it might join with forces opposed to that change.

Davidow, also a former president of the Institute of the Americas, said the reform, if passed, likely would be slowed in state and federal courts. "We are talking about significant change that may take the whole next sexenio (six-year term) before it is ready to go," he said. He said the subject could be a top issue for mid-term congressional elections in three years and said the Mexican legislative tendency toward consensus could water down the reform. A constitutional amendment would require a two-thirds vote in Congress, plus half of state legislatures' support, Martin said.

Davidow said that although some Pemex and Mexican Energy Ministry officials talk positively about changes that have taken place in petroleum sector rules and regulations, "I think most people who are involved in hydrocarbons in Mexico would say that for all of the changes that Pemex talks about, in energia hoypoint of fact, the net effect, the results, have been minimal.... Nothing has really changed."

Here is how Santiago Barcón introduced the conundrum Mexico faces in article in the June issue of Energia Hoy: "While in the United States the objective is to grow more quickly and obtain the benefits of shale gas, in Mexico we continue debating whether we will keep the same energy model we have been using for 70 years or copy Petrobras without deeply examining the differences between Brazil and Mexico."

Barcón said that in the United States, there are no doubts about what model to use: The debate instead is how to implement it. He worried, however, about the damage shale gas extraction could cause to aquifers.

Peña Nieto's proposal
Peña Nieto told Contenido the following when asked what actions he would undertake if he took office. "First, an energy reform so that Mexico has more resources for its development and so that homes get lower electric bills; a labor reform that facilitates the generation of more jobs and that respects the acquired rights of workers; and a fiscal reform so that taxes are fairer and so that government spending goes for what people want, not more bureaucracy."

He likely will need all three; all three likely will be extremely difficult. Barcón said little improvement can be done at Pemex without a major restructuring of the oil workers union.

On the PBS Newshour on Monday, Peña Nieto campaign coordinator Luis Videgaray said the PRI, because of its traditional ties with organized labor, "could deal with the unions better than the other political parties." He added, "Only Nixon could go to China. Well, maybe only the PRI can open the economy and get through an energy reform or a tax reform."

In an article entitled "The candidates offer changes, but don't make clear how they will accomplishment them" in Energía Hoy, Pedro Mentado Contreras called Peña Nieto's proposals conservative and said it is unclear how he will achieve them. He said Peña Nieto wants to bring in private investment to make the sector grow in the areas of exploration, production, refining and infrastructure. Peña Nieto also wants to make Pemex more efficient, along the lines of what Brazil and Colombia have done with their national oil companies, and eventually wants to trade Pemex on the stock market. He also wants to develop a renewable and sustainable energy infrastructure, using hydrocarbon revenues to get it started and ideally produce cheaper and less contaminating energy. Building more refining capacity would reduce Mexico's current dependence on gasoline imports from the U.S. Peña Nieto has not said how many refineries he would build. López Obrador, candidate for a leftist coalition led by the Democratic Revolution Party, has campaigned on a platform of building five refineries. Many experts, however, say it is much cheaper for Mexico to take advantage of excess refining capacity in the United States rather than build extremely expensive refineries. López Obrador has likened Mexican imports of gasoline as the equivalent of the country growing oranges and importing orange juice; however, building an orange juice plant is a far less complex matter than building a refinery.

Mexico's bets depend on continuing high oil prices

Mexico's major candidates are all hoping changes in the petroleum sector can help drive the economy to a better place. Although gasoline is heavily subsidized, the politicians talk of reducing energy prices. Many of the candidates' plans are dependent on high world oil prices and might tumble like a house of cards if prices fall. American Chamber of Commerce of Mexico chief economist Deborah Riner, speaking at the Institute of the Americas, said dramatically lower oil prices could balloon the nation's public sector debt and negatively affect the exchange rate over time. (A video of her remarks appears below)

North American energy revolution: can shale gas be a savior for Mexico?

Davidow said a natural gas boom that the United States is experiencing through tapping gas trapped in shale formations could expand into Mexico.

"We may be living through a major energy revolution in the world and in particular in North America," Davidow said. He said developments involving shale oil and gas mean that the "dependency of the United States ... on the rest of world for petroleum and gas will go down. It could go down very dramatically in the next few years."

He said Exxon "is investing much more money in the production of natural gas these days than in the production of oil. And other companies are following suit."

The United States, he said, "may become a major exporter of energy, particularly liquefied natural gas."

He said, "Mexico has an opportunity, if it can work out these big problems, of really taking advantage of that."

Martin said Mexico could benefit from the natural gas boom because the shale formations where natural gas is being extracted in United States "don't stop at the border."

Davidow concluded: "It is exciting in Mexico because for the first time you have a sufficient number of politicians and opinion leaders who have gone beyond the taboo and are talking about a real change in that country. My concerns are that the opposition that could come from the streets, from the political left, from the new student movement, from a PRI that is divided with thousands of vested interests, could keep Mexico from doing what most serious people now believe has to be done as a way of attracting private investment." He said that if the reform does not happen, "Mexico will not only see its current situation diminish but will lose the opportunity to take part in what is this revolution, this exciting revolution. So, we'll see what happens."

Mexico also is exploring major investments into wind and solar energy. This also is complicated because of restrictions imposed by Mexican energy law.

Martin wondered, "Is natural gas competition or complementary in terms of renewables?"

Energía Hoy reported that Erik Winther Pederson of the wind energy company Suzlon recently told Milenio that Mexico had only installed 600 wind turbines, but that if it could install 20,000, that could provide 20% of the country's electricity needs. The magazine also said Soriana is building a wind park with 30 turbines to produce 54 megawatts of electricity to power its 565 supermarkets.
Update, June 29: Soriana, with opening of new Tijuana market, now reported to have 587 stores. Story, Frontera (PDF).

Mexico also could save by buying U.S. natural gas, which is far cheaper per unit of energy used than gasoline.

Cecilia Aguillon, director of market development and government affairs at Kyocera Solar, said she does not hear Mexican officials talking about nuclear power now. "I hear them talking about importing natural gas," she said. This could be a way to help reduce electricity prices, which are relatively high in Mexico.

Jeremy Martin video

Why is natural gas so much cheaper than other forms of energy in North America?

In many parts of the world, natural gas prices are on a par with gasoline prices for the amount of energy they produce. But in North America, natural gas is much cheaper.

Institute of the Americas President Charles Shapiro said his understanding was that in the United States, "Gasoline costs seven times what natural gas costs."

Davidow said, "Because we are producing so much natural gas, the price keeps going down. Oil and gas companies are desperately looking for ways to raise the price by internationalizing the sale" and shipping gas to Asia, for example.


Deborah Riner video

Jeremy Martin's talking points

Year Mexican oil Production Imports Taxes
2004 3.4 million barrels a day    
2011 2.5 million barrels a day  

Over 30% of government income comes from Pemex: It pays $63.5 billion in taxes, nearly six times what top 100 companies on Mexican stock exchange did combined

May 2012   gasoline imports reach near-record high  
2020   Production could fall to the point that Mexico could become an oil importer, according to some estimates  

 

Enrique Peña Nieto,
Institutional Revolutionary Party
Josefina Vázquez Mota,
National Action Party
Andrés Manuel López Obrador.
leftist coalition
wants to overhaul energy section, allow more private investment; this will require constitutional amendment, 2/3rds vote in Congress plus half of state legislatures support also would allow more private investment in energy sector Would build five new refineries to deal with gas imports; wants more energy investment in Mexico's south

 

Martin and Duncan Wood's article in U-T San Diego on Sunday.
Davidow's article in U-T San Diego on Sunday.

Previous article on alternative energy and Baja California.

Director, Energy Program