Opening the Future of Mexico’s Energy Sector

 

Takeaway

  • Mexico’s Congress voted this year to allow private and foreign companies to participate in the country’s oil and gas market
  • The laws that enable the reform could be passed by August — but Mexico’s ruling political party, PRI, cannot enact these laws alone
  • Challenges include regulatory hurdles, workforce constraints, security concerns, and legal uncertainties

Seven months after passing a historic energy reform that opens up its oil and gas sector to private and foreign companies, Mexico is set to debate the secondary legislation that will determine the future of the country’s energy sector. Mexico has world-class oil and gas resources but has struggled in recent years to extract them; the pending 21 secondary laws that need to be modified or created will establish the legislative framework for the sector.

Despite the fact that the ruling PRI party lacks a majority in Mexico’s Congress and thus cannot enact these laws alone, experts believe that the package of secondary laws could be passed by August. What the final version of that package will look like remains to be seen, though there are four primary challenges to the reform’s success that carry important implications for companies, political observers, and voters alike.

New Regime, New Regulations

First, the most obvious question surrounding the secondary legislation is the nature of the new regulatory and fiscal regime. Historically, political leaders and public opinion have been skeptical of private and especially foreign companies. Even the current government, despite its desire to open the sector, has exhibited a clear tendency to retain control over major aspects of economic development in the country.

Mexico, though, needs to attract private companies for its energy sector to recover and grow. These companies — industry giants such as Exxon Mobil, Chevron, Royal Dutch Shell, and several others — are global enterprises that will not invest in Mexico if its regulatory environment is uncompetitive. The supervising government institutions, then, must provide a level playing field and not overburden private firms with regulations if they are to prevent an institutional bottleneck for investment.

A particularly urgent question is the status of Pemex, the state-owned energy company that until now has held a monopoly over the energy value chain in Mexico. Some are concerned that Pemex will be unfairly favored over private companies, but most observers worry that Pemex will instead be hampered by its relationship with the state, which may threaten the positive impact of energy reform.

Pemex’s tax burden is such that in the past ten years, it has only twice cleared a small profit after its state contributions. Such a tax obligation has undermined its ability to invest in research, technology, human capital, and other integral components of successful companies. Furthermore, Pemex has been subject to budgetary oversight. The lack of budgetary autonomy has similarly hampered the company’s ability to be competitive. If the heavy tax burden and lack of budgetary autonomy remain, it will be difficult for the country’s most advanced energy company to successfully compete with private and foreign enterprises.

Human Capital Shortages

Second, Mexico is on the cusp of a significant boom in jobs related to the oil and gas sector but also of a short-term human capital crunch. Factoring in the private and foreign companies set to begin operations in Mexico, the 160 petroleum engineers graduating each year from Mexican universities will fall far short of the demand.

Human capital shortages do not only impact the private sector. On the regulatory side, it is estimated that the National Hydrocarbons Commission alone will require a specialized staff of 500 to 600 people to regulate the energy sector; it currently employs 51.

Mexico has long struggled to boost higher education in the country, and it now urgently needs to fortify human capital in energy-related sectors more generally. The Mexican government should promote bridge building between national and international universities, companies and think tanks to promote human capital development in Mexico so that the citizenry can reap the benefits of the expanded energy sector.

Security Costs and Social Considerations

Third, there are questions of security and social stability that present challenges to Mexico’s long-term energy success. Many of the most interesting shale prospects are in the northeast of the country, which coincides with many of the hot spots of Mexico’s drug-related violence. While this could stave off some foreign investment, most international energy firms are accustomed to operating in hostile environments. Their decision to operate in Mexico will depend on the projections of security costs versus potential revenue. Of course, greater security in that region will raise the attractiveness of investment opportunities and thus job creation for local citizens.

In addition to security threats, oil and gas investments in Mexico may present social challenges. Southern Mexico, for example, is more indigenous than the north, with a legacy of community land and less commercial experience. As a result, treatment of the community propiedades, many of which lie on land with potentially great reserve deposits, must be delicate. Extra care should be dedicated to establishing negotiating and meditation mechanisms between local communities and energy companies to prevent the damaging flare-ups that have hurt development efforts and split communities in Mexico, Ecuador, Brazil, and other countries with substantial indigenous populations.

Another potential social challenge related to this reform surrounds the perhaps unrealistic promises made recently by the Mexican government that energy prices will drop in the wake of the reform. While prices should decline in the longer term thanks to greater production and efficiency, the government in theory will have little control over fluctuations in price as the energy sector transitions from a state-owned monopoly to a more open environment, while facing questions of regulation, security, and international competition. The government will need to take care to manage expectations in order to avoid either undermining public support for the reform — and thus political will to continue its implementation — or engaging in potentially costly interference with the energy market for populist ends.

Questions of Legality

Public support may also affect the legal viability of the energy reform, the fourth primary challenge, depending on the outcome of the Mexican left’s efforts to have a referendum on the legislation.

The Party of the Democratic Revolution (PRD) and its affiliated social movement, Movement for National Regeneration (Morena), have called for a consulta popular on the energy reform to be held in conjunction with mid-term elections in 2015. The party will likely meet the requirements of collecting the (verified) signatures of two percent of the voting-age population (approximately 1.6 million) to get the consulta on the ballot, as well as generating a turnout of at least 40 percent of the population for the referendum results to be valid.

The pending question is whether a consulta can legally take place on this reform, as the government claims that it is a tax issue and thus constitutionally prohibited from referendums. All sides will closely watch Mexico’s Supreme Court case and decision on the issue, likely to take place in November. The left is betting on the skepticism regarding the reforms to strengthening its bargaining position on the implementation, while the government is hoping for the reform to be up and running by the time a consulta takes place.

Mexico’s energy reform represents a historic opening of a sector long closed to competition, and it carries substantial opportunities for Mexican energy production, employment in a range of energy-related sectors, and overall economic growth. The secondary legislation will be closely monitored for its ramifications on Mexico’s regulatory regime and thus the Mexican energy sector’s international attractiveness and social and environmental protections.

As the legislature debates the details of the nearly two dozen laws that must be amended or created, the Mexican government and political observers should also focus on human capital building, security and social stability, and navigating the legal environment surrounding the reform. The gains of the reform will be more widespread and sustainable if Mexican citizens are protected stakeholders in Mexico’s efficiently regulated new energy landscape.

Photo by Eduardo Pavon / Flickr Creative Commons

 

About The Author

Kate Putnam

Ph.D. Candidate, Department of Government, The University of Texas at Austin

Katie Putnam is a Ph.D. candidate in Government at the University of Texas at Austin. Originally from California, she studied abroad at the...

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