Opinion » Mexican Energy Reform: Downside Risks

Mexican Energy Reform: Downside Risks

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By: Charles B.
Published: March, 2014

Last December, Mexico took a crucial step toward a brighter economic future. The United States’ southern neighbor abandoned its fully state-owned approach to energy production, in search of joining North America’s energy revolution. A constitutional amendment opening the energy sector to private investment moved with ease through both houses, and in a few days, it received a Facebook-style approval in sixteen state assemblies.

Mexico kept subsoil oil and gas as resources originally owned by the nation, but it is going to allow private exploitation in exchange for royalties and taxes. Not bad from a free market point of view: no more Pemex monopoly and well-defined property rights, to start with. For electricity, the grid remains state-owned, in what economics textbooks refer as a natural monopoly. In other words, an electricity market will appear in Mexico.

But the next phase is setting up all these markets. It was expected that Enrique Peña Nieto, Mexico’s president, would send the broad package of laws establishing reform by February 1st, the date the Mexican Congress opens its session. He did not. What could be the reasons for this? Is it just a matter of complexity, or are vested interests are already influencing Peña Nieto? Let’s review some downside risks that may become future problems for prospective investors.

National content. This topic was woven into the constitutional amendment stemming from the fear that all energy profits will go to foreigners arriving in Mexico with superior technology and broader expertise. Of course, that fear is nonsense, as NAFTA, now 20 years old, shows. But this sentiment plays well for protectionist ears and well-connected suppliers. Successful energy projects in Mexico may be hurt by excessive regulation, and the menace for potential investors in Mexico lays not just in higher costs due to national content requisites, but from national content inspectors created for the Ministry of Economy. We hope this temptation does not materialize.

Bureaucratic expansion. Pemex and CFE (the state-owned power utility) are overstaffed entities with above-average earnings for their employees. Their union bosses are famous for their personal fortunes. But in the new model, chances are that a lot of cash may be at stake from performing other bureaucratic duties. Looking at the new constitutional framework for energy, one discovers that a new state agency in charge of environmental safety is coming. But why not let PROFEPA (the Mexican version of EPA) do the job? And for industrial safety standards, why not let the National Hydrocarbons Commission (CNH) and the Energy Regulation Commission (CRE) do a job they already undertake, although on a smaller scale? Who knows what other government agencies may be lobbying for new jobs? Public scrutiny is needed, not just because potential investors are awaiting the new rules, but also as a healthy way to ensure that all decisions are not made by bureaucracies.

“Round zero.” Before any auction of lots suitable for oil and gas exploration takes place, there will be a chance for Pemex to choose which locations it wants to keep for itself (although Pemex may shop around looking for partners to develop the project). This period is known as “round zero.” A too-generous round zero may translate as a preemptive strike by Pemex to remain the dominant player, which would not be usual behavior for a monopoly. However, the Mexican government would be severely damaged by this situation, since expectations of higher production and tax revenues by the year 2018 would not be realized. Mexico will vote for a new president in 2018. Hence, another downside risk is an initial allocation that goes beyond Pemex’s real capabilities; pressures in this direction can’t be discarded.

Strategy Business Group will continue to follow the Mexican energy reform process very closely in order to give intelligent advice to our subscribers and clients. We are convinced that there will be tremendous opportunities for energy projects.

All opinions expressed are those of the author. Strategy Business Group Blog is an independent and neutral platform dedicated to generating debate around the key topics that shape global, regional and industry agendas.

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