Felipe Calderon, Mexico’s quietly determined president, may have pulled off an unprecedented victory with his administration’s landmark fiscal reform. Whether he can do so with energy reform – in many ways the more intractable challenge – is far from clear.
But the urgency is profound: the production of crude, oil exports and reserves are all declining. Moreover, a drop in oil prices has set off alarm bells not only about the course of Mexico’s fiscal revenue and spending, but also about how to turn around the fortunes of the national oil monopoly, Petroleos Mexicanos (Pemex).
The challenge for the world’s fifth-largest state-owned oil company is staggering. For one, it is very inefficient; it is also saddled with costly benefits for its unionized workers and handicapped by having to transfer over 70% of its revenues to the federal government.
What’s more, by the end of the year, the oil giant will have lost 400,000 barrels a day in production of crude, and exports will have slipped below 1.4 million barrels a day. The downstream segment – including maintenance of distribution network and terminals – is the most woefully under-funded, industry analysts say.
Security along the 2,400 miles of energy pipelines has also been thrown into sharp relief following attacks last month on pipeline infrastructure. On September 10, guerrillas of the People’s Revolutionary Army, or EPR, set off six explosions on natural gas pipelines that landed a blow to the country’s industrial sector.
Energy reform has been under consideration for nearly a decade. But ever since Congress rejected a 1999 move to open the electricity monopoly to private investment, neither the president nor lawmakers have come forward with a blueprint for a modern energy sector.
Something to agree on
But even in a divided Congress, there is general consensus that the state-owned firm needs to invest more in exploration. Lawmakers, after all, passed last month’s fiscal reform, which grants Pemex an additional $3 billion a year through a tax break that tweaks the Pemex fiscal regime. More specifically, it mandates a reduction over time of royalties paid on extracted hydrocarbons from 79% to 74% in 2008, dropping to 71.5% in 2012 – in exchange for greater efficiency.
If those funds were used to invest in drilling, the money would increase Pemex exploration investments by more than 20%. Yet even this is hardly enough for costly deep-sea drilling.
“It is a shortfall for what Pemex and the country needs to invest to compete with the rest of the world in comparable areas,” says George Baker, president of Houston-based energia.com, a specialized energy intelligence firm. Last year, capital expenditures in the North Sea peaked at $5.6 billion, and similar investments in the Gulf of Mexico total $2 billion per year for BP alone.
The Calderon administration remains hazy about how it will reshape Pemex, which is shielded by a constitution that defines hydrocarbons as the exclusive property of the state. “In part that is desirable, because the issue has been overexposed in the past,” says Sergio Rosado, associate director for Latin America at Cambridge Energy Research Associates (Cera).
Future Shock
To secure an energy reform, Calderon would have to beef up his party’s minority bloc to a two-thirds majority in both houses of congress and carry a majority of the 32 state legislatures. As a result, most analysts do not believe an energy initiative would be floated until after the July 2009 mid-term elections.
Ultimately, the reform must address a host of issues, including the relationships between sector institutions including Pemex and the finance ministry’s tax agency, incentives for operations including prices, the regulations for private-sector participants and how profits are to be allocated, says Rosado.
Issues as yet undefined include whether a reform would cover only hydrocarbons or the power sector, which is also dominated by public monopolies; whether it would include downstream and upstream segments; and whether a focus on increasing production would mean deepwater exploration or extracting more crude from marginal fields.
The other problem is that amending the Constitution to allow for private participation in oil is among the most inflammatory issues a Mexican president can tackle: the prospect of relinquishing even a drop of the country’s oil wealth touches the most profound national sensitivities.
A gradual approach could have positive results because “reform takes a lot of time and planning,” adds Rosado. Setting out the legal framework and industry institutions would put the rules in place before opening downstream segments of hydrocarbons to a growing number of private participants.
There is hope yet: Calderon’s style for legislative initiatives – defined by gradualism and pragmatism – has a precedent in the successful fiscal reform. The administration will eschew the all-or-nothing approach that failed previous governments. For energy, this means that Calderon will not seek full-blown liberalization.
Nevertheless, says Baker: “Somebody has to take the case to public opinion, starting with the president; you have to say this change is needed.”