Conflict Between the Cash Cow and the Sacred CowWed, 01/20/2016 - 15:15
For years, the future of Mexico has been closely linked to the oil industry, and more specifically, to the state-owned oil company, PEMEX. That relationship is based on the government’s heavy reliance on the NOC for tax revenues. Historically, taxes from PEMEX accounted for about one third of the Mexican government’s income. However, changes are afoot. Mexico has reduced reliance on oil revenues to below 20% of the tax base, but this reduction has not been entirely pre-planned and voluntary. While the government deserves some credit for easing PEMEX’s tax burden, the NOC also suffered over $30 billion in losses during 2015 and faces record levels of debt. The good news is that Mexico has increased non-oil tax revenues through a fiscal reform and, as a percentage of Mexico’s gross domestic product, oil constitutes half of what it did a couple of decades ago. Manufacturing and other sectors are helping to fill the fiscal gap that PEMEX left behind. Looking ahead, the government needs to build on these successes by consolidating the fiscal reform and improving tax collection practices.
In order to successfully attract necessary investment in the energy sector, Mexico needs to create (1) a clear framework for private investment with attractive economic terms, (2) competent and independent regulatory authorities, and (3) an efficient bidding process with balanced contracts and adequate transparency. Nevertheless, we have to evaluate the outcomes of Mexico’s Energy Reform in the context of the worldwide collapse in oil prices. It is also worth remembering that the reform ventures into uncharted territory for Mexico. What we are witnessing is certainly a historic landmark, but the practical implications are just as real. Relatively inexperienced regulatory agencies are navigating brand new legal frameworks while engaging the private sector on multiple fronts in unfamiliar ways. The learning curves are steep and numerous. After some early setbacks, the regulators have done relatively well so far, all things considered. Despite extraordinarily difficult market conditions, Mexico has managed to hold successful auctions and attract some quality bids. People quickly forget previous efforts in Mexico to hold bidding rounds for oil projects, namely the integrated service contracts after the 2008 Energy Reform and the multiple service contracts before that, which failed to reach the expected outcome. One encouraging sign is that some early mistakes in the contracts and the bidding process were corrected after regulators responded to market feedback. There is much work to be done, but there are some positive signs too. The upcoming and highly anticipated deepwater auctions are a major test.
Any sovereign government setting out on this path faces tradeoffs between maintaining sovereignty and attracting private investment on favorable terms. A similar game of give and take occurs in trade negotiations between sovereign nations themselves. In that sense, Mexico’s current sovereignty tradeoffs are par for the course and approximate industry-standard international practices. That said, with more attractive price conditions, Mexico’s regulators could certainly be more aggressive in setting the tone for auctions as far as fiscal terms, government take, and other bidding and contractual terms. Economic conditions have impacted the standard for what constitutes “good enough” terms for the Mexican government, as well as for the private companies bidding on these projects. Today’s energy industry is certainly a bidder’s market.
I characterize the historic role of PEMEX as simultaneously serving as a cash cow and a sacred cow in Mexico. As a cash cow, the NOC shouldered a disproportionate and unsustainable share of the government’s fiscal base. As a sacred cow, it has existed in a highly protective but stifling legal environment. PEMEX was asked to do the impossible. Responsible for covering all of Mexico’s needs, it was run much like a ministry of the government, while prohibited from forming partnerships with other energy companies. The weight of these dual roles was even heavier before the Energy Reform, which has eased some of the burdens on PEMEX. Nevertheless, many questions about the future of PEMEX remain unanswered. For instance, we have yet to see how the farm-outs or joint ventures between the NOC and other energy companies will take shape. A significant amount of progress is needed before it can become an internationally competitive enterprise.