Normative Narratives

Economic Outlook: In a Well Timed Shift, Mexican President Embraces FDI in Energy Sector

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Total Oil Produced in barrels per day(bbl/day) Mexico

Original Article:

President Enrique Peña Nieto of Mexico on Monday, pushing one of the most sweeping economic overhauls here in the past two decades, proposed opening his country’s historically closed energy industry to foreign investment.

Mr. Pena Nieto’s goal, like those of presidents before him, is to recharge Mexico’s economy by tackling areas that analysts agree hinder its expansion, which has averaged just 2.2 percent a year since 2001, according to the Organization for Economic Cooperation and Development.

Perhaps the worst of those is the creaky energy sector. Demand for energy in the country is growing so fast that Mexico could turn from an energy exporter to an energy importer by 2020, the government says.

Already, Mexico must import almost half its gasoline, mostly from the United States. Mexican companies pay 25 percent more for electricity than competitors in other countries, the government says. Although Mexico has some of the world’s largest reserves of shale gas, it imports one-third of its natural gas.

“With the reform that we are presenting, we will make the energy sector one of the most powerful engines in the economy,” Mr. Peña Nieto said at a ceremony to present the plan on Monday.

Mexico’s left-wing parties have been adamant that the Constitution’s 75-year-old prohibition on private investment should remain ironclad. From the right, the National Action Party, or PAN, proposed energy reform last month that would go even further than Mr. Peña Nieto to invite in private investment.

Public opinion is also suspicious about opening up the industry. A survey last year by CIDE, a Mexico City university, found that 65 percent of the public opposed private investment in Pemex, the state-owned oil monopoly.

The proposal would allow private companies to negotiate profit-sharing contracts with the government to drill for oil and gas. Under such a scheme, the reserves would continue to belong to the Mexican state, but investors would get a share of the profits. Private investment would be allowed in refining, oil pipelines, and petrochemical production.

Since the 1994 North American Free Trade Agreement exempted energy from Mexico’s broad economic opening, presidents have attempted to loosen the prohibitions that give Pemex sole control over all oil and gas exploration and production. No joint ventures are allowed. Those past proposals have often withered in Congress.

But this time, the precipitous decline of Mexico’s energy industry may work in Mr. Peña Nieto’s favor.

Pemex, which was long an important source of crude imports into the United States, is spending more to pump less. As Mexico’s giant Cantarell oil field in the shallow waters of the Gulf of Mexico has declined, production has dropped 25 percent from the peak in 2004, to just over 2.5 million barrels of oil a day.

At the same time, the amount the government budgets for Pemex to invest has steadily climbed to $26 billion this year. To increase production and reserves, Pemex needs to drill in the deep waters of the Gulf of Mexico and in onshore deposits of shale oil and gas. But the company has neither the capital nor the expertise to increase production significantly, analysts say.

There are a number of reasons why now is the proper time for Mexico to open up its energy industry to FDI. Mainly;

1) Economic: Loose monetary policy is conducive to FDI. Investors can borrow at historically low rates, while energy is a relatively safe investment (if anything energy prices will only go up as the global economy strengthens). Even if Mexico puts strict regulations and high taxes on foreign operations (which it certainly should, more about this later), the opportunities for a relatively low risk-high reward investment exist. These factors will attract many potential investors, allowing Mexico to drive a harder bargain and secure the best deal for the Mexican people.

2) Political: Political instability and armed conflict in the Middle-East and Northern Africa make Mexico’s main competition for FDI much less attractive. Venezuela and Russia ramped up anti-Western rhetoric in recent months; the trust needed for large-scale investments may be compromised. Look at the updated 2013 Political Risk Map;  Mexico is arguably the most politically stable major oil producing country, both in terms of internal stability and in a regional context. When considering investing in extractive industries–with high start-up costs and very asset-specific capital investments–peace, stability, and trust are very important components of any deal. These factors are often more important than traditional “race to the bottom” incentives.

The Mexican people are right to be wary of private investment in their natural resources. Natural resource rents can be a powerful tool for human development, if they are used the right way. However, globalization in extractive industries in the past decades has been marked with human rights violations, corruption, exploitation, and violence. This so called “natural resource curse” is not inevitable, but without proper oversight and accountability, “bad” governments will always be willing to cut lucrative deals from themselves and private corporations, at the expense of society as a whole. 

I do not see this as an issue in Mexico for a few reasons. Primarily, the linkages between governance, extractive industries, corruption, and sustainable human development are now well understood by the international community. Mexico, by waiting to liberalize it’s energy sector, has the benefit of adopting best practices / avoiding worst practices from past ventures. There is also a strong belief in Mexico that the oil belongs to the people. Political opposition, once the energy sector is liberalized, will manifest itself as “watch-dog” organizations and other social accountability mechanisms. Social accountability (aided by social media and ICT), relatively good governance at the global and national level, alongside the comparative advantages addressed earlier, suggest that Mexico will have a very positive experience liberalizing its energy sector (assuming the political will to develop exists).

If Mexico’s natural resources stay underground, they cannot be utilized for development purposes. The article cites a lack of capital and expertise holding back the Mexican energy sector–FDI addresses both of these impediments.  A new trend Mexico may want to utilize is having private investors pay for development projects–such as schools, hospitals, or other human capital enhancing institutions–as a way of signalling the investors desire for a mutually beneficial and long term relationship. Furthermore, because of high taxes, private companies will make it a point to run operations as efficiently as possible, maximizing both their share and Mexico’s share of profits. A quadruple layer of private, governmental, international and social accountability will exist, diminishing opportunities for  embezzlement and corruption by state or private interests.

The time is right for Mexico to liberalize it’s energy sector from a policymaker and investors point of view. However, this does not necessarily mean that the Mexican lay-man will agree with this assessment. The Mexican people’s distrust of FDI in extractive industries is understandable; it is the Mexican governments job to educate the public, assuring them that policies and safeguards will be put in place to ensure that liberalizing the energy sector benefits society as a whole, not just vested interests.

“It is fine to appeal to rationality, but when it is about these issues, it’s indispensable to touch the audience’s heart,” wrote an analyst, María Amparo Casar, in the Excelsior newspaper last week.

In a democracy, big policy changes generally require popular support. The rational political economy argument for liberalizing Mexico’s energy sector is strong. The remaining road block is convincing the Mexican people that such liberalization is in their best interests.

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One thought on “Economic Outlook: In a Well Timed Shift, Mexican President Embraces FDI in Energy Sector

  1. Pingback: Mexico Legislating Open Energy Market for Private Sector | LANDsds Sustainable Voice

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