Miriam Grunstein
View from the Top

Challenges Match Opportunities in Mexico’s Structural Changes

Mon, 09/01/2014 - 16:02

Q: How will changes to the oil and gas industry alter the makeup of the Mexican economy?
A: Their impact will largely depend on the government’s capability to incorporate the changes to the energy framework into the economy. After all, E&P can drastically change without affecting the rest of the economy as Mexico will still behave like a commodity exporter. However, it would be interesting if the energy sector changed its dynamics to become better integrated into the rest of the economy, thus reducing our fiscal dependence on oil revenues. Oil revenues are reasonable sources of income for countries but a problem arises when there is an absolute fiscal dependence on such revenues, which has been the case in Mexico. PEMEX’s role as an important fiscal provider will last for another 15 to 20 years, but no more than that. Nevertheless, we have to take into account that companies entering Mexico will not pay high taxes at first while they develop fields. For deepwater, it might take ten to 12 years before the country produces its first commercial barrel. Once this happens, Mexico will be able to bring in fiscal revenue, but not before. Anyway, for that to happen, Mexico will need very competitive fiscal terms to get companies to come here. Easier projects might face tougher fiscal terms, including mature fields and areas that still have not been awarded to service companies. This means PEMEX is going to need to clean up its act. It can be a player in new areas but it cannot afford to stay more than 12 years in Cantarell, KMZ, Bellota-Jujo or Samaria-Luna, as those reserves will be depleted after that.

Q: How will the Energy Reform change the position of Mexico within NAFTA?
This primarily depends on the outcome of the Energy Reform and the secondary laws, which are going through a difficult stage of negotiation. Companies will come here if the fiscal terms are attractive and Mexico provides legal certainty through a framework that ensures institutional safety. Oil and gas companies are no strangers to risk, as evidenced by their work in Iraq, Nigeria or Venezuela, but the risk must be kept within reasonable bounds. Preserving our current position in North America as a long- time oil producer will largely depend on the guarantees we can give to investors. The way markets develop depends

on public institutions; if the institutional framework is not clearly laid out in the secondary laws, companies are going to flee or partake in corruption. The midstream and downstream segments are largely dependent on changes in the upstream. Nobody will come to Mexico for refining endeavors or to build infrastructure if the access to hydrocarbons is not guaranteed. In terms of the downstream segment, just as the US has been dependent on Venezuelan refineries, I think Mexico will also become dependent on Venezuela’s refineries as we become more integrated into the northern hemisphere. Mexico has to pay attention to its relationship with Venezuela, as we might need them for infrastructure.

Q: How do you view the future of the pending trans- boundary agreements?
A: It is a matter of branding. Operators on the US side of the Gulf of Mexico are investing in deepwater because they have the infrastructure. We are going to have them on our side of the border producing our oil without a trade agreement. To reach such an agreement would require Mexico to have clear information on its commercial reserves, which it does not have today. We may say that we have about 50 billion barrels of oil in deepwater, but that is an estimate. Another important aspect is that we have no idea how much of that oil is trans-boundary. What is likely to happen is that IOCs are going to extract our oil, whether trans-boundary or not, and hand it down to Mexico with or without a trade agreement. This could even work through a licensing contract, since that is not an issue anymore. Our operator could be Shell or any other company.

Q: Which mechanisms within the government would have to change for oil revenues to be properly managed?

A: Oil revenues have to be reinvested; to get wealth, one must add wealth. Social investments are also crucial as this is where the redistribution of oil revenues happens. The reserves are still the property of the nation. It is fair that these funds should be reinvested in social programs, but transparency, equality, and cleanliness are essential. Revenues should be directed to education, health, housing, and productive infrastructure. Furthermore, while I do not object to funds being used for subsidies, these subsidies must be targeted to the segments that need them, not for people to pay less for gasoline for their SUVs. Mexico has never been very good at this, so my concern is that money might come in but with little information as to where that money is going. This can be changed, but changing the Mexican fiscal culture is a rather different thing. If a more successful Fiscal Reform had been in place prior to the Energy Reform, I would be more optimistic. Instead, we saw a reform that puts pressure on the middle class and that does not raise taxes on large companies, while Mexico still has a gigantic informal sector. I do not see a change in Mexico’s fiscal hygiene that ensures oil revenues are going to be better administered.

Q: What are the implications of PEMEX’s transformation into a ‘productive enterprise of the state’?

A: That subject is going to be puzzling. The only way to have a real company in Mexico is by incorporating it as such, acknowledging that it will have a commercial chapter. To clarify the situation, the Article that lays out how the state is composed should be amended by the current administration. If not, a company like PEMEX cannot be truly autonomous as it will remain inside the government’s administration. Slight changes could be made, such as allowing PEMEX to manage its budget more independently. Nonetheless, PEMEX will remain dependent on the government’s administration and I think that its board members will be directly linked to the state. This situation is highly murky.

I think PEMEX will take a dive in the coming years as, unlike Petrobras and Ecopetrol, it is not being allowed to become a real company. Curiously enough, the only way to save PEMEX at this point is by allowing it to become publicly traded. For example, 25% of the stock could be publicly traded, meaning its executives would become responsible to private investors who do not want to lose their money.