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The Madero refinery in Ciudad Madero, Tamaulipas - one of six refineries operated by state oil company Pemex. (Photo: Pemex)
Duncan Wood, Director of the Mexico Institute at the Wilson Center.
Thursday, July 26, 2018
Perspectives

AMLO & Mexico’s New Energy Model


Will Mexico’s energy model go forwards, backwards, or sideways?

BY DUNCAN WOOD

The 2013 Mexican energy reform by the administration of President Enrique Peña Nieto put in place a new energy model that, for the first time in 75 years, allowed foreign and private investment in the oil and gas industry and fully opened the electricity sector to private investment in generation. Widely hailed around the world for its ambition, reach, and speed of implementation, the reform has resulted in commitments of more than $220 billion and a dramatically improved outlook for Mexican oil production and reserves.

Despite this success, the reform is far from popular among the Mexican population. Rising gasoline prices in recent years, combined with a continued fall in Mexican oil production and an ongoing crisis in the national oil company, Pemex, have driven a negative opinion of the reform and encouraged anti-reform rhetoric from opposition politicians.

Andrés Manuel López Obrador (AMLO) has long been a fervent and deeply committed opponent of an opening of the hydrocarbons sector in Mexico. He has repeatedly spoken out passionately about the need to maintain state and public control of the country’s oil wealth, maintaining a nationalistic vision that hearkens back to the nationalization by President Lazaro Cardenas in 1938. Now he will have the opportunity as President to reverse the 2013 reforms if he so wishes. However, such a course of action would have highly negative consequences for the industry and for government revenues.

THE 2013 REFORMS

After 75 years of running a closed and monopolistic model in its energy sector, in December 2013, the Mexican government won Congressional approval for a far-reaching reform package that liberalized both the hydrocarbons and the electricity sectors. This paradigm shift happened in the face of considerable opposition from left-wing parties and nationalists, but the Peña Nieto government was still able to win a two-thirds majority in both chambers of Congress and approval from a majority of the state legislatures. Over the next two years, the Mexican Congress passed implementing legislation, and regulatory frameworks and organisms were constructed.

The results thus far have been impressive. 107 contracts have been awarded for oil and gas exploration and production to 69 companies from many different countries, and it is expected that these contracts will deliver over $160 billion in investment. Furthermore, the new oil barrels will deliver an average of 74 percent in government take (royalties and taxes combined).

In the electricity sector, the reform has also been successful in attracting interest from international capital. Several billion dollars of investment have stemmed from the power auctions that took place between 2015 and 2017, with more than 7000 Mw of capacity to be installed. The electricity generation prices offered by the investors for these projects were dramatically lower than established prices in Mexico, and they continued to fall as the auctions proceeded. Perhaps most importantly in the short term and for national competitiveness, the price of electricity for industrial consumers fell by 50 percent relative to its pre-reform level.

The reforms also managed to bring renewed and massive interest in cleaner energies. Wind and solar projects received massive interest from investors and a new system of Clean Energy Certificates (or CELs in Spanish) promises to encourage further long-term investments.

However, the reforms still require significant improvements to maximize their potential. A recent Wilson Center/IPD Latin America publication, while recognizing the advances made by the reform, identified a large number of areas where future administrations must focus their efforts to facilitate operations and increase revenue for both private investors and the state.

AMLO AND ENERGY POLICY

Since his unsuccessful presidential campaign in 2006, AMLO has pushed for a Mexican energy sector that is tightly controlled by the state. Although his 2006 election platform opened the door to the possibility of private (but not foreign) investment in the oil industry, AMLO has since then presented a fervently anti-opening vision of the future.

In particular, in 2013, when the Peña Nieto government first announced its plans to liberalize energy in Mexico, AMLO directed his fury and passion against the reforms, but was ultimately unable to attract much interest from the Mexican public, even when he combined forces with his former allies in the PRD party. However, the short-term results of the reform have provided him with more ammunition in his ongoing battle against the new energy model. Rising gasoline prices due to the end of subsidies, the weakening of the peso versus the dollar and, more recently, rising crude oil prices, have led large sections of the Mexican public to conclude that the reforms have been a failure. The ongoing problems of Pemex, especially in regards to corruption, its financial balance, and its dramatically declining oil production, have helped compound the idea that the reform has not delivered on its promises, despite the fact that these problems existed prior to the reform. Lastly, the much-vaunted benefits of the reform in terms of new oil production, new fiscal revenues, new jobs, and higher economic growth, have not materialized in the four years since the reform was passed. This was to be expected, but the Peña Nieto administration made the fatal error of selling the reform to the Mexican public along these lines.

In his 2018 presidential campaign, AMLO laid out plans for the energy sector that are an unusual combination of old and new ideas. He has committed to the transition from traditional to renewable energies, but his approach is heavily focused on distributed generation and granting access to electricity to marginalized communities rather than large-scale projects. He subscribes to the idea that Mexico needs new hydroelectric plants, although there are limited options for constructing new capacity, and projects would likely face considerable opposition from local communities. On the other hand, his “Project18” plan for the energy sector commits to keeping existing thermoelectric power stations (some of which are powered by burning fuel oil) in operation despite rising fuel costs, aging equipment, and a heavy carbon footprint. This may be seen as a way to avoid massive new investments, but it would almost certainly be a false economy.

But it is in the area of the hydrocarbons industry that AMLO has put forward his most controversial ideas. He proposes restructuring the sector by investing heavily in refining capacity, the exploration and production of natural gas in Mexico, reviewing the contracts and bidding requirements for the oil blocs that were awarded to private and foreign investors since 2015, and significant new investment in, and dependence on, Pemex to develop the nation’s declining oil reserves.

These ideas mark a dramatic departure from the trends of the past 12-18 years in Mexico. The efforts of the Fox, Calderon and Peña Nieto administrations to modernize the energy sector relied on increasing the role of the private sector. AMLO’s plan is focused on three concepts: satisfying the needs and wishes of the Mexican population, re-inserting the state into the energy sector, and adopting an approach that focuses on maximizing production in Mexico.

A COMPLEX ROAD AHEAD

This vision of Mexico’s energy future was clearly laid out during the campaign period and, as noted in the introduction, the AMLO government will have a clear majority in Congress and might even be able to pull together a super majority in both chambers to allow for constitutional reform. Morena already controls a majority of the state-level legislatures, which is the other requirement for changing the constitution. AMLO himself has stated that he would not seek constitutional reform during the first half of this mandate, but the administration’s plan does call for changes to the secondary legislation surrounding the 2013 reform. This will be a major test of the new government’s intentions and will provide clues as to how far-reaching and drastic the changes will be. Another important clue will come from changes that are made to regulatory institutions and the regulatory framework for which they are responsible.

Aside from the legislative and regulatory front, there are a number of factors that the new administration will have to take into consideration when planning its management of the energy sector. The first of these concerns the reaction that any reversal of the 2013 reform would draw from global markets and foreign investors. AMLO has committed to reviewing the contracts that were awarded between 2015 and 2018, a process that was extraordinarily transparent and adhered to international best practices. There can be little doubt that the contracts themselves are valid, but there have been hints from within the AMLO camp that some of the winning firms should not have pre-qualified so as to be able to bid on the contracts in the first place. If this is indeed the approach, then it will have to be handled with the utmost delicacy and care. Any suggestion that contracts are being unfairly revoked will be met with deep concern by investors, and not only those in the energy sector. As AMLO is determined to avoid financial volatility, he must step carefully on this front.

The second factor that the incoming administration must take into account concerns oil production. Although Mexico’s national production has been in steady decline since 2004 (losing over 1.5 million barrels per day since then), the new exploration and production that has come out of the energy reform will begin to pay dividends by the middle of AMLO’s term. Although we do not have a reliable estimate of how much new oil will flow from the contracts, it will certainly be somewhere in the range of several hundred thousand barrels per day. This new oil will be essential to providing AMLO with sustained national production levels and with the crude to feed the new refinery capacity that he plans.

The third major factor that must occupy the incoming administration’s energy planners follows on from this new production. The fiscal revenue that will come with new production will be essential to fund the AMLO government’s plans for social and infrastructure spending, and the 74 percent average government take from the contracts will be most welcome in the effort to maintain balanced budgets. Although the economic fundamentals and the fiscal outlook in Mexico appear to be sound at the time of writing, the new government must be concerned about maintaining and raising revenues at a time when demands on the public purse will surely increase.

The new AMLO administration inherits an energy sector that has begun to turn around after decades of neglect. The 2013 reform was hailed by investors around the world as a sign that Mexico was open for business. In the next few years, the government of Andrés Manuel López Obrador must decide on a path for the sector. There is no doubt that the President-elect wants to increase the role of the state and is leery of the benefits from private and foreign investment.

However, economic, fiscal, and energy necessities may bring the new government to opt for a less radical departure from the status quo than many fear.

Duncan Wood is the Director of the Mexico Institute at the Wilson Center. This article is excerpted from the new report Changing the Guard in Mexico: AMLO’s Opportunities and Challenges from the Mexico Institute at the Wilson Center. Republished with permission.

 

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