Fernando Cruz Galván
Director - Energy Segment
Kannbal Consulting
Expert Contributor

Mexico’s Dilemmas in Facing the Energy Transition

By Fernando Cruz Galván | Tue, 04/13/2021 - 15:43

The debate regarding Mexico’s energy future has intensified. The 2013 Energy Reform consolidated the participation of the private sector in both oil and gas production and electricity generation. The latest reports from AMEXHI show an overall investment approved by CNH of US$41 billion, where US$16 billion relates to investment already executed, generating about 14,000 jobs, and achieving production targets (actual and 2024 forecast), just to mention a few highlights. In the electricity market, the diversification of participants in generation is a reality, and the cost per MW/h of renewables is indisputably lower than fossil-based production.

But where is Mexico heading in regard to its energy future and why do we still have dilemmas about the direction, and especially the right policies, for this sector?

Regarding oil production, the direction set by the government is clearly based on an ideological mindset that assumes that PEMEX should be leading and controlling the oil market, which, in fact, already somehow happens as the actual production share is 97 percent for PEMEX while private operators have only 3 percent. However, unlike PEMEX, the private sector is experiencing gradual and firm growth as exploration and development of their assigned blocks continue to progress very closely in line with their plans. As of 2020, private production was close to the plan of 57mb/d, and the target of reaching 280mb/d in 2024 is realistically achievable. At the other end, PEMEX’s initial targets set by the current administration has proved to be unrealistic. The NOC’s production has only reached around 1.6mb/d when the initial plan aimed to reach 2.4mb/d in 2024. In recent reassessment, the target now seems to be limited to no more than 2mb/d, which is still optimistic given the poor performance of key projects by PEMEX that are focused on increasing production and the company’s heavy financial debt. Only the federal government’s fiscal support is allowing it to survive.

With gas production, the recent crisis caused by climate conditions in Texas triggered a contingency situation for Mexico, as is well known. Most electricity generation in Mexico depends on LNG imports from Texas (96 percent of Mexico requirements are imported). Even though Mexico has self-production, it is limited and used mostly by PEMEX for its own processes (about 71 percent). The rest is a marginal contribution to the domestic industry, including electricity generation.

According to the International Energy Agency (IEA), global demand will recover from today’s 94Mb/d to 104Mb/d in 2026, assuming a base case for 2021, which is a reassessment of the pre-COVID trend. However, there are alternative scenarios in which, depending on factors such as efficiency, behavioral changes, increase in the number of electrical vehicles in the market and especially, the reinforcement of energy policies around the world, demand levels could be contained to lower than 100 Mb/d. The 10Mb/d increase in demand so far will be supplied by the Middle East Region (41 percent), the US (16 percent), Brazil (12 percent) and 31 percent from the rest of the world. Based on the above, the first dilemma for Mexico is whether or not to push for more imported supply or should we focus on efficiency of actual production and supply for the domestic market? In other words, should we focus on a more self-sufficient market and depend less on external supply?

The government’s approach is clearly toward self-sufficiency, which, in my opinion, is not entirely tragic provided it includes private participation. The problem is the “how’s.” By pushing regressive policies, the government’s position is harming one of the key foundations of the actual economy: investment certainty, while the global trend is to move toward policies aligned to facilitate the energy transition in which the dilemma of being autonomous was left behind long ago. Therefore, it is positive to have some certainty in managing and accessing inventories (LNG storage, gasoline, petrochemicals, etc.) when needed but not going against the logic of the global market and, especially, isolating sectors of the economy from the world. This will only stress the ability to nurture a competitive economy and in the long run, the problems will be multiplied.

Another dilemma is related to global climate change commitments (and I mean that it is a dilemma for countries like Mexico and not for those where this has not been a dilemma for a long time now). Even though some developed countries are clearly on the path to achieving midterm and long-term targets,  the rest of the world is not necessarily heading in same direction and with the same speed, given the enormous gaps between developed and undeveloped countries, where the material possibilities of the latter to reach such targets are quite small. Should developed countries do more and help others in this transition? Is Mexico well positioned to meet its climate change targets? Should Mexico prioritize domestic energy problems, even compromising climate change commitments, in exchange for immediate results?

Mexico, unfortunately, will not meet its 2024 targets given the trend and direction of the energy policies followed so far, but the problem here is the cost for the Mexican economy because this trend will likely lead to controversies that will become an obstacle for foreign trade and especially the loss of the opportunity to develop a robust and sustainable energy sector to be able to compete with other regions. It is as simple as that. For instance, the automotive industry has been a champion exporter for Mexico, but this industry is highly sensitive to energy costs. Here, the risk is having to compete at a disadvantage versus China, India, Brazil and other countries where labor costs are getting closer to those in Mexico but probably with more efficiency in terms of energy costs. So far, we’ve been subsidized by the proximity and inter-dependence with the US economy but eventually, as the US transition gains speed, we will suffer competitive challenges that will become ever harder to face.

Energy self-sufficiency and autonomy for Mexico (at least in the Mexican government’s view) seems to be the solution to our energy challenges, but this seems to be a case of having a solution that is more expensive than the problem. The reinforcement of public policies in regard to energy is key, as stated by the IEA in different forums. The implementation of policies takes time to produce results and for Mexico, we will challenge our ability to ensure a resilient economy in the long-term in exchange for short-term relief oriented to solving the dramatic financial shortfalls of government entities such as PEMEX and CFE, without fixing the root problems of low efficiency, higher headcount than any benchmark, unfocused investments and lack of structural reorganization to turn losses into profits while focusing on affecting a market balance in their favor. In other words, trying to adjust reality to the vision instead of the other way around.

The third dilemma is related to the construction of transport infrastructure and in back-up energy infrastructure. Should we focus on traditional investments, assuming a fuel-based market, or should we invest in transition and future developments needed to incentivize the use of electrical vehicles? In line with this, should we build infrastructure to increase oil and gas production or should we focus on transitional gas storage and investing in a robust electrical grid to support future transportation needs? This is not a dilemma in developed countries where the infrastructure is more aligned with the future of transportation and is progressing. In the case of Mexico, it is a dilemma. I would insist that this shouldn’t be a dilemma but unfortunately it is right now. The problem is that the investment in infrastructural projects is limited to building a refinery, airport and a train where ROI is not certain (and likely negative) and cost over-runs are materializing rapidly, alongside continued deterioration of public finances potentiated by the constant and increasingly heavier support to bolster the weak finances of PEMEX and CFE. At the end of the day, this will lead to a financial deterioration in which Mexico would have to pick investments from the low-hanging fruit of projects whether or not they are aligned with energy transition and climate change targets.

I believe we actually have a number of dilemmas in front of us that shouldn’t be dilemmas considering the energy transition is here and moving forward and accelerating changes that impact markets and the global economy, in which Mexico has a prominent role in the North American block where trends, in some respect, lead the global economy. In this transition, the importance of energy policies is key to determining the direction of changes in a country and then the success of achieving the climate change commitments for 2050. But policies should be designed starting from the foundations of each country’s vision about the future. In the case of Mexico, we clearly are traversing a turbulent environment with politics and elections on the horizon, affecting and polluting any productive discussion about what should be our energy vision as a country and what are the right policies to manage the transition and the efficient approaches to secure energy sources and meet future energy demand. This should be done in a positive environment for both public and private investment, either domestic of foreign.

After the midterm elections in Mexico, we might see more space for productive debate and then chances to build the right policies for the future. That will depend also on the new balance of government as well as our proximity to the US and the materialization of changes in its energy policy.

Photo by:   Fernando Cruz