Mexico’s Timid Energy Reform

After weeks of speculation, yesterday Mexican president Enrique Peña Nieto unveiled his proposal to reform the country’s sclerotic energy sector. The move has been heralded by the media as Mexico’s boldest economic overhaul since the signing of NAFTA in 1994. However, even though the reform aims at relaxing the grip of the country’s state-owned monopoly on oil production, it falls short of significantly opening the sector to much needed private investment.

The reason for so much caution is well-known: The government’s monopoly on oil production is the third rail of Mexican politics. Ever since President Lázaro Cárdenas nationalized the sector in 1938, Mexicans commemorate the event every March 18. School textbooks mention the nationalization as a defining moment of Mexico’s history. It is no wonder previous attempts to break up the monopoly of Petróleos Mexicanos (Pemex) have so far failed.

This, of course, is the result of decades of propaganda by Mexico’s long-running governing party, the PRI (to which Mr. Cárdenas belonged). It skillfully embedded a nationalist attachment to the oil industry in the population’s psyche while using Pemex to extract and distribute jobs, rents, and power. However, the party is rapidly coming to an end.

Due to lack of investment and a highly politicized and inefficient corporate structure, Pemex’s oil production has fallen by a quarter in the last decade. The government uses Pemex as a milk cow to finance almost a third of its spending. That leaves little money to invest in the exploration and drilling of the huge reserves of deep water oil that Mexico has in the Gulf of Mexico. Thus, Mexico imports gasoline despite having Latin America’s third largest reserve of oil.

Peña Nieto’s energy reform contemplates changing three articles of the constitution to allow private companies to pump oil, not through concessions as in most other Latin American countries, but via profit-sharing agreements. That is, the Mexican government will pay private companies for the oil they produce, but the companies won’t have outright ownership of the oil.

Unfortunately, the reform doesn’t contemplate allowing the sale of Pemex shares, as proposed by Mexico’s conservative opposition party PAN. Not allowing the sale of Pemex shares will significantly limit the chances of improvement in corporate governance of that white elephant. As The Economist points out, Pemex is plagued by mismanagement and political meddling. Energy reforms in Brazil in 1997 and Colombia in 2003-2006—which the Mexican government is pointing to as successful examples—involved not only allowing concessions for private companies, but also limited private ownership in Petrobrás and Ecopetrol, respectively. These moves have been credited with improving the corporate governance of these oil companies.

The politics of energy reform will certainly be tricky. Even though Peña Nieto has the support of most of his own PRI party and the PAN (which, when combined with other congressional allies, have more than two-thirds of the votes in Congress), the constitutional amendments will face stiff resistance from the left-wing PRD party. Its former presidential candidate Andrés Manuel López Obrador is calling for massive protests in Mexico City.

Peña Nieto will try to convince Mexicans that energy reform will result in cheaper gasoline. However, that isn’t clear since the government heavily subsidizes gasoline prices. According to an article by John Scott from CIDE, a think tank, Mexico is among the countries with the lowest gasoline prices in the OECD. How energy reform will alter these subsidies, which amounted to 6% of GDP in 2006-2012, remains to be seen.

Peña Nieto’s efforts to bring more private investment to Mexico’s oil industry should be commended. However, even if his energy reform is approved, Mexico will still have the most tightly state-run energy sector in the Americas (even more than Cuba and Venezuela). That, in itself, should indicate how much room for further reform will be needed.