Mexican Energy Reform: Politics and Predictions

On August 13, Mexican president Enrique Peña Nieto addressed his nation, introducing his proposal for the reform of the country's energy sector. Petróleos Mexicanos (trademarked and better known as Pemex), the state-owned monopoly in place since 1938, has faced declining profitability in recent years, and without reform, projections for the company's future are grim. Because of nationalist passions, this is a sensitive issue in Mexico. Bearing this in mind, in his address, Peña Nieto appealed to the country, stressing that reform of the energy sector is the only viable path forward for Pemex and Mexico.

Despite its current place among the top-10 oil exporters in the world, Mexico remains on the path of becoming a net oil importing nation within the next decade. All three of the country's leading political parties acknowledge this reality and the need for deep, structural changes to the Mexican energy sector. Without profound reforms, the hundred-year-old link between the oil sector and the government will continue to politicize the debate-and limit the Mexican Congress's ability to enact the improvements that will most benefit Mexicans.

A set of reforms implemented throughout the first 60 years of the twentieth century transformed Mexico's energy sector into one of the most-if not the most-closed of its kind. Private investment in the exploration, production, and distribution of hydrocarbons is prohibited, giving Pemex, a state-owned firm, control of the entire production and supply chains. Absent other firms to learn from and to share risks with, Pemex faces technology and knowledge gaps and the company is falling behind international parameters of innovation and productivity.

When he assumed the presidency in December, President Peña Nieto vowed to modernize the energy sector's business model, bringing it in line with the dynamic reality of today's Mexican economy. The reforms his administration has pushed for so far (of education and telecommunications, for example) have passed with relative ease, thanks largely to the "Pacto por México" (Pact for Mexico), a compromise among the three political parties, hammered out so that they might work together in the country's best interests.

The energy bill, however, is a different "beast" entirely.

The leftist Party of the Democratic Revolution (PRD) is fundamentally at odds with the other parties' proposals regarding energy reform and will likely refuse to cave. As a result, Peña Nieto will most likely be forced to break the Pact, working exclusively with the political right to pass the sought-after energy reform.

Peña Nieto announced his plan earlier this week while the center-right National Action Party (PAN) released its plan last month. The PRD's plan, as yet unannounced, will be considered alongside all other proposals this fall, when Congress reviews the bill. So what are the politics that will determine Mexico's energy sector reform?

Q1: What will happen if a reform bill is not approved?

A1: The past decade has seen a 20 percent decrease in Mexico's national oil production, and its reserves have plummeted by 41 percent in the same period. If nothing is done, at the current rate of decline Mexico will become a net-zero oil exporter by 2019.

The energy sector's business model is outdated, and Pemex lacks the capacity to work alone in this new era of unconventional oil production. Mexico's so-called "easy oil"oil that is easy to access with conventional technologywill soon be depleted, making exploration and production still more expensive and challenging, particularly in the deep waters in the Gulf of Mexico.

But expense is not the only issue, and so increasing Pemex's budget is not the solution. The company's budget increased fivefold in the last ten years alone, but production, patents, and revenues have failed to increase in kind. To take full advantage of Mexico's proved and probable crude oil reserves, Pemex would require at least 12 times its 2013 budget and an increase of this magnitude is simply unrealistic.

And adjustments to Pemex's budget ignore a still larger problem. Income from the energy sector makes up roughly one third of the government's revenue. If the industry is not restructured and Pemex's production continues its steady decline, government revenue will suffer and the potential effects could include a full-blown budget crisis.

Q2: What reforms has each party proposed?

A2: Each of the three political parties has taken a different stance on energy sector reform. Their positions and the likely outcomes are as follows.

The PRD: The political left favors a reform with 12 legal amendments but none to the constitution. This includes removing the state-owned monopoly from the federal budget, making Pemex financially autonomous. The reforms likely to be included in the party proposal are expected to allow for limited private investment in transportation and refining and would modify, but not eliminate, the tariffs and subsidies to fuel and electricity.

By modifying the industry's financial structure, the bill would enable Pemex to invest more of its revenue in technology and human capital. Still, Pemex would have to either buy older technology or engage in the years-long research and development process. However, as long as public-private ventures remain illegal, technology transfers from oil multinationals will stay well out of reach.

Assessing this proposal must take into account the outcomes of President Calderón's 2008 reforms. Though the reforms allowed the auction of fee-for-service contracts, Pemex has failed to attract bids from oil giants abroad in the most recent bidding rounds, as foreign companies expected those investments to be unprofitable. With risk-sharing contracts still outlawed as under the PRD proposal, Mexico and Pemex will continue to miss valuable foreign investment opportunities-and further reform will likely be needed in short order.

The PAN: The political right's bill, the most ambitious of the three, seeks to modify three constitutional articles. The bill would remove Pemex from the federal budget, revise the fiscal regime, and gradually phase out the tariffs and subsidies currently in place.

Most importantly, the PAN's bill would break the state-owned monopoly in every level of the production and supply chains. Any and all operators, Mexican or otherwise, would gain the right to compete or partner with Pemex for concessions in the exploration and production of petroleum, shale gas, and other resources and would be allowed to produce and distribute refined products.

This plan also includes the sale of a portion of Pemex's shares in an attempt to make the company function more like a profit-maximizing entity, though the state would still own more than half of the enterprise. This business model mimics Statoil's Norwegian state-owned oil firm. The Norwegian government holds 67 percent of the company's shares, having partially privatized the entity in 2001 and Statoil's success since then is undeniable. Proponents argue that Pemex would enjoy similar success should the country adopt the PAN model.

The Institutional Revolutionary Party (PRI): Though President Peña Nieto's PRI proposal includes constitutional amendments, it is seen as the middle ground between the previous two options.

The PRI's reform would ensure Pemex's budget autonomy and limit (but not eliminate, as in the PAN proposal) the power of the workers' union in the company's decisionmaking process. The bill refrains both from selling any shares of the state-owned company and from the industry to competition in the upstream, though it allows for competition downstream.

Under this new structure, Pemex could partner with other enterprises in profit-sharing contracts-but concessions to private companies would remain off-the-table. Moving forward, the Mexican government would then have the right to provide firms other than Pemex with opportunities to explore and produce oil in the country, with the profits split between the firm and the state.

Q3: What is the likely outcome of the reform process?

A3: As of this week, three proposals are on the tableone from each party. Given the party structure, and especially should the government seek to preserve the Pacto por México, legislators will have to come together willing to compromise if the much-needed reform of the energy sector will move forward.

In all likelihood, the reform bill enacted will most closely resemble the PRI's proposal. President Peña Nieto's popularity, his party's power, and its position as a moderate political force together ensure that the PRI's interests will be most closely reflected in the final bill.

That said, energy reform will likely sway slightly toward the PAN's proposal. PAN legislators significantly outnumber their PRD counterparts, and the former's party line is more closely aligned with the PRI's. To bring enough lawmakers on board, the PRI may well appeal to the PAN by compromising on less controversial issues, reaching for the low-hanging fruit: risk-sharing and further limits on unions' power come to mind.

Even in compromising, the PRI will likely continue to shy away from any steps to break the state-owned monopoly, given the broad opposition to such a move by Mexican citizens.

To be sure, a PRI-PAN deal on energy reform would carry certain political consequences, likely among them the end of the Pacto por México and the legislative productivity that came along with it. The PRD has announced that it will push for a national plebiscite regarding energy reform, explicitly threatening leaving the Pact should the results of the plebiscite be ignored. And a number of groups have threatened staging nationwide protests in early September in response to the reforms.

Conclusion: New technology and talent have given oil and gas producers access to previously unreachable natural resources, kicking off what can only be described as an energy revolution. And given the recent discovery of unconventional gas and petroleum in North America, the region should be at the forefront of this movement.

However, Mexico remains at the margins despite its large natural resource endowment and will remain there until it leaves its historical commitment to a strict, nationalized oil industry behind.

The failure of the 2008 reform hopefully taught Mexico a valuable lesson: energy reform without amending the constitution sentences the effort to failure. The constitutional framework is itself outdated, and constrains the viability of the Mexican energy sector.

If the Mexican Congress passes the constitutional amendments, Mexico could help itself and North America achieve their full potential, positioning the region as a global driving force of a revolutionary and revolutionizing energy industry.

Carl Meacham is the director of the Americas Program at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Tania Miranda, intern scholar with the CSIS Americas Program, provided research assistance.

Critical Questions
is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

© 2013 by the Center for Strategic and International Studies.

Carl Meacham