From Stratfor
There are just about six weeks to go until Mexico’s new president takes office, yet policy in one area that has attracted some of the hottest speculation, energy, remains very much a work in progress. Leftist President-elect Andres Manuel Lopez Obrador — popularly known by the nickname AMLO — rode a wave of public discontent with the incumbent administration and corruption to the presidency. On the campaign trail, however, Lopez Obrador also directed his ire at another bugbear: the country’s 2013 energy reform. The politician’s persistent attacks on energy reform largely focused on higher fuel prices for consumers, although he also denounced the incumbent administration’s move to open the exploration and production of the state-owned oil and gas resources to private capital.
And now that Lopez Obrador is about to assume power, it’s becoming clear that his administration is exploring options to craft an energy policy distinct from that of his predecessor, Enrique Pena Nieto. Although the incoming administration has leaked numerous potential policy choices to the press, just a few plausible options are emerging — in part because the country’s economic and fiscal realities have narrowed Lopez Obrador’s options. What’s more, the options on the table do not appear to confirm investors’ worst fears that Lopez Obrador would overhaul the 2013 reform in its entirety. Instead, the new administration will try to raise capital for additional exploration, production and refining, while also moving to grant state-owned Petroleos Mexicanos (Pemex) a more central role in resource management than the law currently allows. But even with the diminished prospect of a rupture in policy from the previous administration, investors might still have cause for concern when Lopez Obrador takes office Dec. 1.
Promises From the Campaign Trail
During his campaign, Lopez Obrador broadly opposed the energy reform for two reasons. First, attacking the reform — which the outgoing Pena Nieto government touted as necessary to lower fuel prices — delivered immediate political gains, as the rise of fuel prices stemming from the deregulation of Mexico’s subsidized fuel market in 2017 and 2018 greatly dented Pena Nieto’s popularity.
Second, Lopez Obrador attacked the reform because of the perceived threat it posed to Mexico’s longstanding state influence over the explorative and extractive, or upstream, oil sector. After President Lazaro Cardenas nationalized foreign oil company assets in 1938, the Mexican state exercised exclusive control over the management of upstream resources. By 2013, the more business-oriented National Action Party (PAN) and Institutional Revolutionary Party (PRI) had come to view private capital as the future, especially as Pemex lacked the capital to reverse declining production from mature oil fields. Both parties accordingly used their congressional majority to sideline the more leftist Party of the Democratic Revolution from exerting any real influence to shape the reform. As a result, more leftist and nationalist political heavyweights, such as Lazaro Cardenas’ son Cuauhtemoc Cardenas (one of Lopez Obrador’s early political mentors) could do little to prevent the passage of a reform that deeply affected the Mexican state’s control over energy resources.
A Hard Dose of Reality
This, however, is where the gap between campaign rhetoric and reality becomes evident: Even if Lopez Obrador theoretically wields the legislative power to reverse the Pena Nieto government’s energy reform, he will not do so, as Mexico stands to lose too much fiscally, politically and economically. Pursuing root-and-branch reform would put Mexico’s new administration at odds with strong domestic business coalitions and increase uncertainty among investors.
Instead, two major drivers will shape Mexico’s new energy policy, namely, the search for capital and a move to overhaul the system of auctioning exploration blocks. The Lopez Obrador administration will search for capital to fulfill its longer-term energy objectives. In so doing, the new government will likely aim to reduce Mexico’s dependence on imported fuel by seeking capital and investors for the construction of at least one new refinery and investing in Pemex-owned oil and gas resources to mitigate the country’s two decades of declining production. Lopez Obrador’s administration will also amend the law governing Pemex’s role in allocating oil and gas blocks to give the company a more prominent role in managing the country’s upstream oil and gas resources. Ultimately, the new administration appears to be committed to continuing the Pena Nieto government’s regulatory opening to private companies — albeit on terms that are more favorable to Mexico’s federal government.
The new policies represent a balance between the more radical and pragmatic camps within Lopez Obrador’s Cabinet. Key officials such as energy secretary nominee Rocio Nahle and potential Pemex exploration and production director Fluvio Ruiz Alarcon have backed initiatives such as the construction of a new refinery to reduce dependence on imported gasoline and diesel. Alfonso Romo, Lopez Obrador’s pragmatic chief of staff nominee, has publicly pledged that there will be no disruptive changes to energy reform amid a general proclivity toward as few changes as possible.
To raise capital for exploration and production, and possibly refining investment, Pemex will consider an initial public offering of its shares. The proposed action, an idea crafted by Pemex’s outgoing directors to raise capital for the company’s exploration, production and refining initiatives, would require changes to secondary legislation outlining the firm’s responsibilities and role. Although the legal framework under which such an IPO would progress remains uncertain, National Hydrocarbons Commission (CNH) regulator Juan Carlos Zepeda likened it earlier in the year to the 2010 IPO under which Brazilian state-owned energy company Petroleo Brasileiro (Petrobras) raised $70 billion through the sale of a minority stake.
But creating the conditions to raise capital for Pemex will be a complex endeavor. For example, any attempt to do so would require Mexican authorities to file documents with the U.S. Securities and Exchange Commission detailing the company’s financial situation. The company’s labor union, the National Oil Workers’ Union of Mexico, has been historically opaque about its budget, drawing allegations that it has engaged in embezzlement, bloated its payrolls and misused government funds. If the reporting requirements for an IPO reveal evidence of excessive spending that could be facilitating graft with Pemex funds, the company may have a hard time attracting capital through any offering.
Reducing waste and corruption associated with the oil workers’ union would require authorities to undo political networks that have weaved their way through the company over the decades. The government may eventually gain the upper hand over the union to reduce graft or force some of the more corrupt members into retirement. Such a process, however, would probably be lengthy, particularly as union bosses would likely resist the reform efforts and potentially encourage work stoppages.
Cause for Concern
The second driver of Mexican energy policy, however, will pose a greater concern for future investors. The Mexican government intends to make Pemex a more central player in managing the country’s hydrocarbons, but what shape that will take, and how Pemex will interact with existing institutions, remains a matter of uncertainty. The new administration appears likely to grant Pemex more leeway in deciding where and how it does business with other companies. Pemex might receive permission to partner with private companies and award oil and gas blocks directly to operators, rather than be obliged to wait for approval from the CNH. For this to happen, however, Lopez Obrador’s administration must change the secondary legislation underpinning the 2013 energy reform.
The government will also continue a review of oil and gas contracts awarded from 2015 to 2018. The intent behind the review, however, appears to be less about discovering corruption (as Lopez Obrador allies and officials have publicly stated) and more about learning how previous administrators awarded the contracts so that Mexico’s new rulers can close any fiscal loopholes, such as by mandating the inclusion of a signing bonus for each contract.
But as the new government moves to make Pemex the dominant upstream player, one key question remains. How will CNH operate in the new system? Will it return to its intended role and complement Pemex in the auctioning process, or will the new government seek to sideline it? Though Lopez Obrador’s spokespeople have said CNH-managed auctions will restart eventually (they remain suspended pending the incoming government’s review of oil and gas contracts), it remains to be seen when and how this will occur. Giving Pemex far greater control over auctions may end up decreasing transparency and raising concerns over the fairness of the bidding process. At the same time, solidifying Pemex influence over upstream bidding may allow the company to hoard certain resources in a fashion that would not be possible under a robust CNH.
The realities of ruling were always likely to sand down some of Lopez Obrador’s sharper campaign promises on issues such as corruption and energy reform. But even if his incoming government might not provide nightmares for investors in Mexico’s energy sector, it seems bound to give them some unsettling dreams.
