How Brazil Outpaced Mexico in Capturing Oil Economic Rent

Mexico likely entered the development of its oil fields at a very early stage because of its proximity to the United States, particularly in what became known as the Golden Belt (Faja de Oro), a geographic area stretching between Tampico and Poza Rica.

In the early 1920s, Mexico became the world's second-largest producer of crude oil, surpassed only by the United States. During a historically unprecedented boom, Mexico produced roughly one-quarter of the world's total oil supply.

While the United States consumed most of its own production, Mexico became the world's largest exporter of crude oil.

Mexican production reached its historical peak in 1921, with total output of 193 million barrels. However, by 1926 production had already fallen below 100 million barrels, and by 1930 Mexico's share of global production had declined from 25% to less than 3%, due to both geological factors and institutional uncertainty, as well as more attractive conditions offered by other countries, particularly Venezuela.

It is important to note that during this period, oil companies — primarily American and European — effectively appropriated the economic rent that rightfully belonged to the Mexican state. At the time, the idea that economic rent legitimately belonged to the host country was not yet fully understood, even though hydrocarbons in the subsoil were the property of the nation, regardless of which operator or oil company invested in developing the fields.

Perhaps because he had served as the military commander of the region encompassing the Golden Belt, Gen. Lázaro Cárdenas understood the oil industry better than anyone else in Mexico. I would argue that, as president of Mexico, Cárdenas was the first head of state of an oil-producing country to clearly distinguish between the financial opportunity cost that legitimately belonged to operating companies and the economic rent that, under the Napoleonic legal tradition, belonged to the host state as the original owner of the natural resources in the subsoil. We are speaking of an era in which oil companies paid virtually no royalties for hydrocarbon extraction — only a few cents per barrel. Cárdenas understood the distinction between profits and oil rent and sought to reflect it in the country's fiscal regime.

Before the expropriation, the Mexican government, despite its limited resources, had succeeded in dividing the foreign oil companies (American and Anglo-Dutch) and reached an agreement with El Águila (the Anglo-Dutch company), under which El Águila agreed to grant the state an economic rent of between 15 and 35% of production from the highly significant and newly discovered Poza Rica field. Later, under pressure from its American counterparts, El Águila withdrew from the agreement in order to align itself with the U.S. oil companies, leaving Mexico with few alternatives. Nevertheless, it is important to emphasize that Mexico — albeit only briefly — anticipated a practice that would become common worldwide within a few years, as demonstrated by the Venezuelan experience only a decade later. This supports the conclusion that President Cárdenas's preferred policy was originally to levy a hydrocarbon royalty equivalent to the oil rent, and that, given the political constraints of the time, he had little choice but to proceed with expropriation. This gave rise to the enduring myth that the only alternative was to eliminate private operators and establish a state monopoly, making expropriation one of the central pillars of Mexico's revolutionary nationalism.

Brazil presents a very different case from Mexico. Until the 1950s, Brazil was not an oil-producing country, and hydrocarbons played only a minor role in its economy.

Petrobras was founded in 1953 by President Getúlio Vargas, a populist leader whose legacy as a champion of workers and president of Brazil has been embraced by Luiz Inácio Lula da Silva. One could say that Vargas was Brazil's equivalent of Lázaro Cárdenas. Despite Petrobras's strong ideological symbolism as a national oil company, oil did not occupy the same central position in Brazil's economy as it did in Mexico. Perhaps for that reason, subsequent Brazilian governments adopted several important economic principles without ideological bias:

1. Oil economic rent is distinct from profit. Economic rent is collected by the state through royalties, while the oil and gas operating company retains only a net profit after paying the rent, which rightfully belongs to the original owner of the hydrocarbons in the subsoil under the Napoleonic legal tradition — a principle absent only in the United States.
2. Economic rent can be multiplied when there are many oil and gas operators, because all of them pay royalties to the state. Economic rent is maximized when each operator extracts oil efficiently, minimizing costs while maximizing the recoverable share of hydrocarbons in situ.
3. A national oil company can promote energy sovereignty and support the state's social objectives, provided that it remains profitable and economically sustainable over the long term.

For these reasons, in 1997, following Brazil's return to democracy and during the administration of President Fernando Henrique Cardoso, a social democrat, the Brazilian Congress enacted Law No. 9,478, which ended Petrobras's monopoly and created the National Petroleum Agency (Agência Nacional do Petróleo – ANP), an autonomous institution responsible for managing the country's hydrocarbon resources without political interference. In 1999, the ANP began awarding oil and gas exploration and production contracts to private operators.

During President Luiz Inácio Lula da Silva's second term, on Sept. 23, 2010, Petrobras conducted a highly successful public offering on the New York Stock Exchange and the Madrid Stock Exchange, raising more than US$70 billion. Today, the Brazilian government owns only 28.67% of the company's shares, while the National Bank for Economic and Social Development (BNDES) and the Brazilian Sovereign Wealth Fund, both public entities, together hold an additional 7.94%.

The successful public offering carried out during the Lula administration confirms the Brazilian government's understanding that economic rent lies in royalties, not in corporate profits.

Despite the well-known scandals involving Petrobras over the past decade, the company has operated as a private-sector enterprise in many respects, as reflected in its relatively high standards of corporate governance and social responsibility.

For most of its history, Brazil was a net importer of oil. It achieved oil self-sufficiency only in 2007. Today, Brazil's crude oil production averages approximately 4.2 million barrels per day, making it the largest oil producer in Latin America.

The fact that national oil companies control more than 75% of the world's proven oil reserves gives producing countries substantial bargaining power vis-à-vis international oil companies. Today, more than at any other point in the history of the petroleum industry, producing nations possess the leverage necessary to optimize and capture the value of economic rent.

Unlike Mexico, Brazil does not carry the same ideological burden regarding oil. Today, the government take — the combination of royalties, taxes, and other fiscal instruments — imposed on oil operators worldwide averages approximately 70% of the value of each barrel produced.