Origins of the Hydrocarbon Law, Part 1By Rajan Vig | Wed, 06/09/2021 - 08:58
Mexico City is slowly returning to normal after the COVID-19 pandemic hit the country and its capital hard. This time last year, the more affluent parts of the city were empty; one could walk in the middle of the road without seeing a passing car. A lot has changed in the past year and it feels like Mexico City along with other parts of the republic has its brio back.
The timing could not be better for MORENA and AMLO’s upcoming midterm elections. The masses will rally to the polling stations and vote binarily to either cement MORENA’s position or demonstrate trepidation after nearly three years in power. There is a lot to consider regarding education, healthcare, inflation, unemployment and economy contraction. Nonetheless, there is one particular sector that AMLO and his party share a certain affinity for and that is the energy space.
For so long, PEMEX was the darling of the Mexican economy. In 1974, Mexico made the leap from an oil importer to an oil exporter for the first time since the 1920s. Before the expropriation of oil companies, and for the majority of the 1920s, Mexico was the largest oil exporter in the world with approximately 80 companies operating in the country.
The Tabasco-Chiapas area, which produced about 60,000 barrels a day in 1970, was producing one million barrels a day by about 1976. Most of that was in the region of Reforma. PEMEX was so powerful that in Tabasco state the constitution was altered to allow the company to have access to land first and pay for it later. In addition to the important discoveries in Tabasco-Chiapas and Campeche Sound, Mexico's refining and petrochemical industry received an important boost with the inauguration of the refinery in Tula, Hidalgo, with a capacity of 150,000 barrels per day. This golden age is what the current government wants to bring back.
However, a significant expansion in exploration, production and the rest of the value chain was financed by issuing foreign debt, a number that quadrupled in four years.
The financing of all of PEMEX’s expansion with debt and using the nation’s petroleum riches as collateral to finance many of the government's programs was the entity’s downfall. Between 1973 and 1981, Mexican foreign debt rose at an average of 30 percent per year, from US$4 billion to more than US$80 billion.
In August 1976, the government devalued the currency for the first time, abandoning the $12.50 parity for $15.69 pesos per dollar. Their efforts were partially in vain as Mexico continued to suffer fiscal pressure and on Dec. 1, 1976, it declared a second devaluation, with which the price per dollar reached $22.76 pesos. In less than two years, the Mexican peso lost nearly half its value against the greenback.
The Década Perdida of the 1980s that enveloped Latin America further accentuated PEMEX’s long-standing issues and grossly damaged Mexico’s debt leverage, leaving PEMEX exposed and the country in dire straits fiscally. The collision of events that followed thereafter caused the national oil company resounding problems that have dented PEMEX since.
A Mexico City propane explosion in 1984 that killed 450 people, followed by dozens of sewer explosions in Guadalajara in 1992, killing more than 200 people, was the nadir of PEMEX as a brand. The series of explosions in the downtown area of Analco was caused by a gas leak, the warning signs of which were ignored by the Mexican government and the national oil company. Mayor Enrique Dau Flores was indicted for ignoring the warnings; he subsequently resigned from office. Eight others in the government and part of PEMEX were also charged in the case.
After the Latin American debt crisis of the 1980s, Mexico was in recovery mode. The creation of the Energy Regulatory Commission in 1992 allowed the private sector to participate in construction, property and operation of pipelines, as well as in infrastructure for liquid and natural gas distribution. In 2008, with the Hydrocarbon National Commission and the renovations performed inside PEMEX, the general outlook improved.
The most significant change in the energy sector was the 2013-2014 Energy Reform, an idea planted by ex-presidents and issued by President Peña Nieto. At the time, it was the most expansive energy reform ever undertaken by a country.
Almost all the value chains of hydrocarbon and electricity were opened for private sectors and clean energy goals were set. This reform finally provided answers to substantial deficiencies in the energy sector that had been stacked up during decades. As the legal framework was modernized, numerous national and international companies were attracted to invest in the Mexican energy sector.
MORENA’s Energy Reform
Turn to 2019 and since the advent of the MORENA administration, the protectionist energy agenda of the current administration has had a profound role to play in limiting private influence above all in the energy sector.
It should be of no surprise then that a new 360,000 barrel per day refinery is being built in the same region where PEMEX struck liquid gold: it is being touted as a modern-day renaissance. This is also where AMLO grew up, gazing at the titanic PEMEX finally fulfilling the expectations Mexicans had for the state entity. By hook or by crook, AMLO and his MORENA party will push for a stronger PEMEX and CFE, even at the risk of this push having negative knock-on effects elsewhere.
The rains have now commenced in Mexico’s capital, earlier than past years. The awesome greyish hue that transcends on the bulging metropolis as the heavens open is a grandiose sight in an equally awesome city. The evening showers are a welcomed sight for many locals as the atmosphere cools but this year, the city inhabitants may be even more grateful for nature’s tabula rasa. Mexico City sits in a valley that contains the weather and also pollution.
After many years of challenging the high levels of contamination, the city is once again facing high levels of environmental spoliation. Why? Simply put, CFE is burning a “bottom of the barrel” fuel oil, purchased from PEMEX refineries, to generate electricity in order to provide PEMEX with a “short” to sell a molecule it produces in abundance since it has no export market to feed as the fuel has been replaced by cleaner technology and better-quality petroleum. The resultant effect of this trade-off is a dirtier environment for Mexicans residing in the country’s biggest cities. The economics seemingly make sense for MORENA, however, and recycles cash flow between the two state companies.
In Part 2, we will consider the origins of PEMEX as mentioned above and analyze both the logic behind the Hydrocarbon Law and how it may affect downstream oil markets in Mexico.