Big Oil Sees Untapped Potential in Mexico

7 MINS READFeb 2, 2018 | 00:14 GMT
Major international oil companies know that the next Mexican president will be limited in any energy reform rollback.

Riot policemen stand behind a metal barrier while supporters of candidate Andres Manuel Lopez Obrador (on poster) rally in Mexico City.

(YURI CORTEZ/AFP/Getty Images)
  • Mexico's energy reforms have begun to pay off, attracting major international companies interested in potentially lucrative deep-water oil opportunities.
  • Populist presidential candidate Andres Manuel Lopez Obrador has promised to roll back aspects of Mexico's energy reform, but his ability to do so will be limited by institutional and political constraints.
  • Mexico's latest round of bidding for new oil exploration and production blocks suggests international energy companies are hardly fazed by the limited threat of Lopez Obrador's platform.

Despite the looming possibility of a populist presidential candidate winning the high office in Mexico, "Big Oil" is betting on the longevity of energy reform in the country. Andres Manuel Lopez Obrador, who currently leads the presidential election polls, is promising to reverse aspects of the country's energy reforms. But from the perspective of the major international oil companies, a Lopez Obrador presidency would be little more than than a six-year nuisance, because he lacks the ability to rewrite the legal fundamentals in a way to last beyond his term.

Revitalizing a Flailing Industry

Five years ago, major reforms brought about a much-needed sea change to the Mexican energy sector. Before then, oil and gas production had been in a free fall, due in large part to the government's restrictive rules. Mexico's constitution granted the state the sole right to explore and produce oil, and the highly politicized and inefficient national energy company Pemex had held a production monopoly since the country's 1938 oil nationalization. By the end of the 2000s, Pemex lacked the necessary capital and the technological prowess to develop many of Mexico's increasingly complex oil reserves, such as those in the deeper waters of the Gulf of Mexico. Moreover, it was forbidden from bringing in the foreign expertise and investment needed to make up for its deficiencies. Oil production in Mexico consequently dropped from 3.8 million barrels per day (bpd) in 2004 to just 2.46 million bpd a decade later.

Mexico City had recognized the need to lessen Pemex's dominance in the oil and gas industry as early as the 1990s. But energy reforms significant enough to make a serious impact required constitutional changes, which Mexico's political landscape around the turn of the millennium rendered nearly impossible. Oil production — and the central government's revenues along with it — continued to decline, and reforms didn't find success until 2012, when Enrique Peña Nieto became president and tied energy reform into fiscal and tax measures.

Within two years, the entire energy sector changed. Pemex not only lost its monopoly, but Mexico City also instituted extremely attractive contract models — including concessions and production-sharing contracts — while building up a robust and independent regulatory structure to oversee the industry. Recently, Mexico has hosted a string of successful bidding rounds, particularly for its deep-water and shallow-water blocks, which have had international oil companies salivating for years. In a Jan. 31 deep-water bidding round, Shell scooped up nine oil production blocks, outpacing rivals such as BP, Eni, ExxonMobil, Chevron, Statoil and Total. And in 2017, multinational oil and gas company Eni drilled the first well by a private company in Mexico in decades, hoping to begin production as early as 2019. These developments all contribute to a growing sense of optimism around the long-term possibilities for the Mexican energy sector.

Trouble Downstream

But this progress has not come without a cost. For international oil companies, the biggest and most important changes that Mexican energy reform brought were in the exploration and production realm, also known as the upstream sector. However, Mexico also overhauled its midstream (storage and transportation) and downstream (processing and distribution) sectors. It's in the latter two areas where Mexico City and Pemex have seen the most pushback from ordinary Mexicans.

Prior to the dissolution of Pemex's monopoly, the company not only provided oil and tax revenue for the government but also offered attractive, well-paying jobs and education opportunities for Mexicans. The national oil company partook in social development projects and subsidized its energy products for the country's population. Since the reforms were implemented, the government has done things such as deregulate gasoline and diesel prices, leading to price increases and other negative impacts. These actions have caused unrest, and in 2017, price hikes sparked significant protests.

The Risks of Reform Rollback

Lopez Obrador, a member of the National Regeneration Movement (Morena), has been tapping into this popular dissatisfaction during his campaign, promising to roll back some of the reforms that have caused price increases. His populist message, especially amid difficult and tense negotiations over the North American Free Trade Agreement, has helped him charge past rival contenders in early polls, earning him a 6-point lead over Ricardo Anaya of the National Action Party (PAN). Polling at about 32 percent, he still faces competition from Anaya and Jose Antonio Meade of the Institutional Revolutionary Party (PRI) in the race, which is shaping up to be extremely fragmented. But Mexican elections do not go to a runoff, so Lopez Obrador can win the July 1 election outright even if he earns just 30 to 40 percent of votes. And if he does, he will certainly use his term to prioritize changes to the energy sector.

However, it's not clear whether Lopez Obrador will be able to rope in enough legislative support to implement any of those changes. The center-left Party of the Democratic Revolution (PRD) may jump on board for at least some of them, but PRI and PAN were the parties that drove the energy reforms in the first place, and they are unlikely to back any Morena policies that counteract their former efforts.

Where Lopez Obrador wields the power to exert some influence over the Mexican energy sector is as the head of the executive branch. He could order a review of all of Mexico's oil and gas contracts, and though he does not directly control it, he might try to pressure the National Hydrocarbons Commission (CNH) to stop auctioning off oil blocks. He could also order the finance and energy ministries to drag their feet and tighten fiscal terms while he conducts a review of current contracts. And the presidential front-runner has even promised a national referendum on the issue of energy reform, which, if it produced a "no" vote, would undercut support for PRI and PAN and force them to the negotiating table. (Mexico does not allow referendums on budgetary issues, however, so any attempt at one could be struck down in court.)

Finally, Lopez Obrador could look to the administration of former Brazilian President Luiz Inacio Lula da Silva for inspiration. The Mexican government modeled its energy sector reforms heavily after Brazil's 1999 changes, and less than a decade after those Brazilian refinements were put in place, da Silva took steps to roll them back. After the discovery of the massive Tupi pre-salt oil field in 2006 (ironically since renamed the Lula oil field), the Brazilian government gave national oil company Petrobras the right to operate and take a large stake in any new pre-salt contract. (In the wake of scandals and a new presidency, that requirement has been removed.) With some legislative support, Lopez Obrador could implement a similar policy, requiring Pemex to take a stake in contracts and potentially also operate blocks.

Taking the Bet

Despite Lopez Obrador's campaign promises, major international oil companies remain unfazed about his potential to disrupt the current direction of the Mexican energy sector. After all, many of the drivers behind the 2012 energy reforms remain in place; Pemex's technological capabilities are still limited relative to its peers, and though the company returned to profitability in 2017, it has continued to struggle with corruption and inefficiency. Lopez Obrador has even begun toning down his initial threats to roll reforms back completely, recently stating that he would not make any changes through executive action alone.

Like all politicians, Lopez Obrador will have to navigate the constraints of his office, and if he is elected, he and the rest of his government will likely show more pragmatism in action than on the campaign trail. Indeed, his team has already been reaching out to the Mexican energy industry's technocrats for advice about how to shape his energy policy. Lopez Obrador will still be able to make some changes, especially to the downstream sector of Mexico's energy industry. But Big Oil will continue to bet on Mexico's upstream energy reform, counting on institutional and financial barriers to protect their investments. For international companies such as Shell, the reward of entering one of the world's last untapped but proven oil-producing regions is greater than the risk of potential reform rollbacks. 

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