The Debate over Energy Reform in Mexico Heats Up

For years, the Mexican economy has been largely dependent on oil, which provides about 35% of the government’s revenues. As a result, Petróleos Mexicanos (PEMEX) is a pillar of the Mexican economy, and everything about the state-owned company is of utmost importance for the country.

 

The people who govern Mexico are driven by a need to transform PEMEX into a more productive company, with improved processes for the exploration, exploitation, storage and refining of petroleum. A whirlpool of opinions and ideas is affecting the government’s energy reform plan, which would change the way PEMEX operates and how it is managed. In political, economic and financial circles, people have begun to make all sorts of critical comments about the concept of reform.

 

Most of these criticisms revolve around the possibility that private capital will be permitted to invest in PEMEX. A wide range of conflicting opinions have been voiced, from the radical nationalists who believe that there is no need to invest fresh capital, to those who believe that this approach is the only way to transform PEMEX into a profitable enterprise.

 

Technical Bankruptcy

 

In March 2008, PEMEX marked its 70th year of operations as an oil company. (Before that, it was a ‘civil association’ responsible for promoting investments in the petroleum industry.) Things have changed quite a lot since 1938. Little by little, the country’s petroleum reserves have continued to decline. Experts have calculated that within 10 years, PEMEX will be in catastrophic condition, unable to produce or refine petroleum. This would force the country to import petroleum or another fuel that generates the energy necessary for everyday activities.

 

Despite the high price of petroleum, PEMEX, which employs more than 100,000 people, is in dire financial condition. In 2007, its debt was more than six billion euros, with accumulated liabilities of 37 billion euros. Why is PEMEX in such deplorable economic condition? Humberto Ríos Bolívar, professor at the Escuela Bancaria y Commercial (EBC), a banking and commerce school in Mexico City, explains that “its management has done very poorly; that’s why it is now in such a difficult financial straits. Every company needs to constantly re-invest and do maintenance. Other companies, unlike PEMEX, reinvest the profits they’ve made whenever that is necessary. If they don’t start by improving the administration [of PEMEX], hundreds of [outside] investors could join the company, but PEMEX would continue to face the same problems, nevertheless.”

 

Although resolving this problem is complicated, experts advise PEMEX to explore and produce oil from deep sea deposits — those more than 1,000 meters below sea level. To do that, the company needs to have enough capital to invest in machinery, technology and know how.

 

Ríos notes that “energy reform is something essential for the country because its production processes are obsolete. The entire energy sector needs reform, not just PEMEX. Everyone talks about bringing in outside investment but reforms must also address how the state-owned company will be managed. It doesn’t do any good to get an infusion of capital if you don’t do the right things with it.”

 

Experts say that reform must be accompanied by fiscal measures that enable the Mexican government to [raise more revenues and] become less dependent on PEMEX. According to Moisés Marcos Benítez, also a professor at EBC, “You have to take into account the relationship between PEMEX and the Treasury. A large portion of PEMEX’s profits play an integral role in the government budget. You have to find a way for the profits that PEMEX makes to be reinvested, so that the taxes that people pay wind up making a contribution to the development of the country.”

 

Obstacles to Reform

 

For all that, turning PEMEX in the right direction will be quite difficult if the government doesn’t reform the entire energy sector. First, you have to revise the law, if necessary, so that Article 27 of the Constitution blocks reform. That article prevents the government from authorizing concessions and contracts for the exploitation of Mexican petroleum. You would have to amend the Constitution and modify the corresponding regulations, even in the best of cases.

 

The situation becomes even more complicated when you consider the various political interests of the different parties represented in the country’s Chamber of Deputies and Senate. Humberto Aguirre Aguirre, also a professor at EBC, notes that “Nowadays, they tend to frighten people by using the banner of sovereignty. What’s really happening is that they confuse the terminology; petroleum is an area that involves national security, but not sovereignty.”

 

Aguirre explains that the reform plan is based on the assumption that “legalizing the right of private capital to participate in the ownership of PEMEX does not deprive the country of its sovereignty. On the contrary, this approach is a positive step toward strengthening its security. Little has been said about this but there are some powerful groups who protect themselves by exploiting the rhetoric of sovereignty. They are the ones who really benefit by preventing private capital from investing in PEMEX. These powerful groups, such as political parties, look out for their own benefits. They look for ways to do win over more supporters in the next elections without thinking about the welfare of the country.”

 

Like a giant snowball, the obstacles to enacting energy reform are growing larger, day by day. Marcos notes that “The government cannot manage the reform efficiently if it is divided into political factions. The PRI wants to enact its reform; the PRD opposes it; and the PAN (the party in power) supports letting in private capital. What we need are agreements that contribute to making the reform perfect.”

 

‘Necessary, Undeniable’

 

For Aguirre, there is no way to deny that energy reform is necessary because “the [Mexican] government doesn’t have the money required for investing in PEMEX. If the government can’t do that, then the private sector should do it. And you need to invest so you can extract crude oil from deep wells.” Ríos agrees. “There are only two sources of investment — government and the private sector. The government has already shown that it doesn’t have enough money to invest. That means you have to let in private investment.”

 

Mexican President Felipe Calderón told the press recently that there are three ways to resolve this situation. “The first way is we stay the way we are. The second is, we devote more of the federal budget [to energy reform], although that won’t be enough. Third, we could look at what other public companies have done around the world.” Aguirre adds that Mexico would hardly be the only country to manage private investment in its energy sector. “Countries such as Spain and Italy have brought private investment into their energy sector, and they have not lost their sovereignty.”

 

The closest model for this approach may be Petrobras, the Brazilian government energy company. For more than a decade, Petrobras has undertaken a modernization process that has enabled it to be at the forefront of deepwater exploration. At the end of 2007, Petrobras discovered a gigantic deposit of crude oil on the Atlantic coast of that country Brazil, which increased its proven reserves by 50%.

 

Nevertheless, bringing private investment into PEMEX frightens people. Ríos explains, “People are afraid because of the bad experiences we’ve had throughout history. The political environment lends itself to suspicion. Why must there be foreign investment? What commitments exist with other countries? The reform must be carried out, but the government must control it.”

 

One of those bad experiences involved Telmex, the telecommunications company. Telmex sought private capital so it could improve, and it wanted to do away with its monopoly on telephone service. However, Telmex continues to have control of the [Mexican telecom] infrastructure. All of the other companies [in the sector] must submit to the will of its telecommunications empire.

 

For all that, when it comes to energy reform, the government must play an extremely important role, notes Aguirre. “It has to provide sufficient guarantees for private investment. The government must maintain control of PEMEX. It must do a perfect job of setting limits on the way everything works, and on how all of the players take part in the business.”

 

Brazil’s Petrobras, a Possible Ally

 

Until recently, people didn’t know which companies were interested in investing with PEMEX. Lately, the news has been filled with talk about a possible alliance between Petrobras and PEMEX. People are already talking about the conditions under which this alliance might take place.

 

Calderón and his Brazilian counterpart, Lula da Silva, have already discussed the possibility of creating a new enterprise – a third company [neither PEMEX nor Petrobras] that would be in charge of drilling for crude oil in Brazilian territory in order to boost Mexico’s oil reserves. The new company would also provide services on Mexican territory without getting involved in those areas that are prohibited by the Mexican Constitution.

 

For Ríos, “the important thing is not how this alliance is carried out or the nature of these investments. The important thing is to set clear rules that prevent any possible conflict. It’s vital to improve the way the company is managed, so you also improve its financial situation.”

 

According to Ríos, another reason for concern has surfaced lately, and it will take time to sort out: What sort of company would invest [in PEMEX] without playing a role in the management of the company? “All investors are looking for reciprocity. No company invests without guaranteeing its capital. Surely, any company that decides to invest will want to take part in that company’s decision-making.” As a result, adds Ríos, “They [PEMEX] should look for loans that have more favorable terms, such as those from the World Bank. Those sorts of loans are designed to provide support in these kinds of cases, and they don’t require that much intervention [by the World Bank]. They merely dictate certain economic and financial criteria that must be followed.”

 

Aguirre adds that “The only way a company invests under these conditions is if you establish the laws that are required for guaranteeing private corporate investment.” In addition, says Ríos, if energy reform is to succeed, “you need to have a plan; we haven’t heard a lot of that kind of talk, but planning is the foundation of every project.”

 

The plight of PEMEX is quite complicated. A series of conditions must be reconciled if energy reform is going to be carried out successfully. The great challenge of the Calderón government, experts say, is to reconcile all of those interests in a way that benefits the country. The government must create the kind of plan that effectively achieves a consensus — the sort of plan that is strong enough to be worth all the effort.

 

On April 9, President Calderón announced that he had delivered his energy reform initiative to the Mexican Senate. His next step is to get the Senate to approve the plan. Later, his reform plan will have to be sent to the Chamber of Deputies (the lower house) for final approval. Calderón has explained that his plan involves placing “citizens bonds” [in PEMEX] that raise enough money to “guarantee PEMEX will continue to belong to every Mexican. For the first time, we Mexicans won’t merely be the owners of our petroleum; we will also profit directly from the earnings the company earns.”

 

The President has also signaled that PEMEX will have financial autonomy. “We will be able to devote more resources to new projects for the exploration and production of petroleum and gas,” he said. “We particularly propose to create special regulations regarding contracting, acquisitions and public works. These regulations will be distinct from regulations in the rest of the government, and they will enable the company [PEMEX] to be much more efficient.”

 

All of this means that the energy reform initiative will provide greater autonomy to the publicly owned PEMEX, so that it can be managed much more efficiently. At the same time, the Mexican government will try to maintain its control over the company. All of Mexico is waiting to see how energy reform turns out.

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