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Currently in the final stage of my doctoral work on the political economy of national oil companies. Here you'll find some of my findings--as well as other musings on oil-related topics. All comments -- civil, civilized or barbarian -- are welcome

Can AMLO save Pemex?—That’s not the question

Can AMLO save Pemex?—That’s not the question

Mexico’s president-elect has sent mixed signals on what he wants to do with the energy reforms of 2013-14: respect the opening and continue to let much-needed private investment in, or stifle the reforms in hopes of resurrecting Pemex to its former glory. But it’s Pemex—overstaffed, underfunded, and woefully uncompetitive—that is the real obstacle to improving Mexico’s oil industry.

July 2018 – SC McKnight

When Mexicans went to the polls on 1 July 2018 to choose their new president, they were in a rock-throwing mood. Feisty like this entry’s national football team—which would lose to their arch-nemesis Brazil the next day at the World Cup—this time the electorate wasn’t going to roll over and vote for yet another establishment candidate. Instead, roughly 53% of Mexican voters—a drubbing by Mexican standards—left no doubt that the political iconoclast Andrés Manuel López Obrador and his message of change, clean government and a sovereign Mexico was wanted.

This piece analyzes what the electoral victory of the man commonly known as AMLO means for Mexico’s stagnating oil sector. For a country that is both a major oil producer and consumer, and one that just years earlier passed comprehensive reforms to open the sector to private investment, this article argues that the real question isn’t what AMLO’s win means for Mexico’s oil sector. Rather, the real question is how does the sclerotic yet still dominant national oil company, Petróleos Mexicanos, better known as Pemex, survive in a sector now open to private investment—and so, competition—or in a sector that closes up again but with little possibility of reviving stagnant production and investment levels.

Mexico’s oil industry has been in trouble for a while. The proximate cause of this decline is geological—that is, its big fields aren’t producing as much as they used to and Pemex doesn’t have the means or knowhow to tap the more challenging new fields. But the long-term, interlocking causes are historical and political—and so, the focus of this analysis.

How Pemex became a sacred cow

Mexico was producing commercially viable oil in significant quantities for the global market before many of today’s oil-producing countries had even sunk a well. Beginning in earnest at the turn of the 20th century, the Mexican oil industry flourished in the 1910s, with production in 1921 reaching about 530,000 barrels per day—a middle-of-the-road sum today but enough to make Mexico the world’s second largest producer at the time (graph 1).

Graph 1: Oil Production: Mexico & Venezuela, 1905-30 (barrels per day)

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That is this decade or so of rapid production growth occurred as the country descended into the chaos and bloodshed of the Mexican Revolution (c. 1910-17) makes the feat even more impressive. Foreign capital and expertise—practically all American and British—brought this industry to fruition, along with a warrior-like workforce of Mexicans and a subservient, practically powerless host-state. After all, this was still decades before the emergence of effectively organized labour, 50-50 profit splits or oil-producing states nationalizing their fields and collectively manipulating production.

With this oil boom came almost shameless exploitation by the oil companies—both in terms of revenue kept from the Mexican state and well-treatment—rushing to recoup their investments before either the in-rush of salt water into the wells or possible expropriation by the Mexican government. Indeed, several post-1917 governments attempted to raise taxes and implement the nationalistic tenets of the 1917 Constitution—both vehemently resisted by the companies—which culminated in the dramatic nationalization of the industry in 1938.

With the basic infrastructure of an industry already established (though admittedly in crisis), foreign firms expelled and embargoing Mexican imports of parts and exports of oil, the Mexican government created its own national oil company, Pemex, arming it with a monopoly to run the oil sector from wellhead to gas pump (pozo a pozo as Mexicans put it). That constitutionally enshrined monopoly lasted some 75 years, till 2013 when the government of Enrique Peña Nieto (2012-18) cobbled together enough across-the-aisle votes to pass comprehensive energy reforms (Table 1). And so, Mexico’s oil industry was (re)opened to foreign investment.

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 A Sacred Cow in Decline

So, what brought about the (re)opening? The state’s need for revenues explains why oil-producing countries engage in what veteran oil scholar Paul Stevens calls the ‘resource-nationalism cycle’—that is, when oil prices are high, the host-state reasserts its control, either through forced renegotiations of contracts with foreign companies or expelling foreign companies altogether; when oil prices are low, the host-state softens its terms and invites foreign companies to invest (again).

Yet Mexico’s oil industry, and Pemex in particular, lived through both the booms and busts of price spikes and crashes. In the 1960s, when Mexico’s oil production struggled to keep pace with rapidly increasing demand, the government was steadfast on maintaining the monopoly—in part fearing the political consequences of letting foreign capital back into its oil industry, in part because Pemex had become integral to the country’s industrializing strategy. When oil production exploded with the discovery of a major complex of oil-producing fields (collectively known as Cantarell) in the mid-1970s, the government turned the oil sector—and Cantarell in particular—into the fiscal lifeline for virtually all of the government’s various plans, with little regard for the need or viability of the projects—or for Pemex, for the matter. Mexico’s oil boom (mid-1970s-early 1980s) turned Pemex into the crown jewel of an import-industrializing economy, primus inter pares among state-owned firms and main generator of subsidies of all kinds—until 1982 anyway, when the debt-ridden Mexican government defaulted and the country was cut off from international lenders.

Oil prices sunk in the mid-1980s and stayed frightfully low till the late 1990s, but again the Mexican government clung to the monopoly. There were several reasons for this: first, there was always the hope of a return to higher prices (which finally arrived from the early 2000s till about mid-2014); second, various post-1982 Mexican presidents, though market-reforming, were nevertheless unwilling to stomach the political war that would result from touching the third rail of oil sector reform; finally, the oil boom had turned Pemex into the major contributor to the government budget, regardless of where oil prices stood and what it meant for Pemex’s ability to reinvest (graph 2). As one Mexican oil insider put it to me, the government had become addicted to oil revenues and couldn’t break the addiction.

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Source: INEGI (various years) and SCHP (2015)

It was from roughly the mid-1980s that the revenue-famine hit Pemex, even if it would take years for the effects to manifest themselves. Decades of underinvestment, rampant corruption, a tax regime that bled the company so as to feed oil-dependent government budgets, and unable to continue to draw the top talent from Mexico’s engineering schools, Pemex was subsisting on the generosity of its rather ‘easy’ oil fields and its constitutionally protected monopoly (graph 3).

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So, it was geology—most specifically, the sharp decline of the prolific Cantarell fields (graph 4) and the shameful reality that Pemex had neither the money nor knowledge to tap resources under the seabed of the Gulf of Mexico—that finally forced the hands of otherwise conservative governments to take on energy reform. The sexenio (six-year presidential term) of Vicente Fox (2000-06) made a halfhearted but thoroughly futile attempt; Felipe Calderon (2006-12) made some inroads but the opening was very limited. It was under Enrique Peña Nieto (2012-18) who found enough support—inside and outside of his party—to push through energy reform.

AMLO: enigma of economic populism and pragmatic ruler

Mexico’s president-elect has backed down on his call for a referendum to repeal the energy reforms—reportedly on the advice advisers and perhaps a change-of-heart that helped him win over otherwise skeptical business-minded voters, especially in Mexico’s northern states. This U-turn on more radical proposals may help explain—in part at least—his electoral success after losing attempts at the presidency in 2006 and 2012.

Reversing the energy reforms would be costly—if not for his large coalition than for the impact it would have on Mexico’s business-friendly image. Markets barely flinched at the announcement of his victory, in part because it was largely a foregone conclusion and therefore had been digested in the months before it became a reality. Instead, as it relates to the oil sector, AMLO has opted for slightly less radical—though still economically questionable—plans to freeze oil prices and to build two new refineries (one in Campeche, the other in Tabasco).

But if AMLO was looking for reasons to reverse the energy reforms, beyond his more vague calls for ‘energy self-sufficiency’ and reasserting Mexican sovereignty, it would be that the opening to foreign investment has thus far yielded rather disappointing results: Mexico’s first auction fell flat, with only two blocs awarded of the fourteen on offer. Later auctions generated better but still suboptimal results. In part, this can be blamed on the unfortunate timing of the passing of reforms, which not only missed the high-price wave that crashed in mid-2014, but that also coincided with Brazil’s reopening of its highly prolific though geologically challenging ‘pre-salt’ offshore to private investment. Among my interviewees, there’s a widespread sense that Mexico missed out, and that now the ball is back in the companies’ court.

Conclusion: AMLO is neither saviour nor false prophet of Pemex

What AMLO would do with the energy reforms became a tantalizing topic of speculation in the lead-up to the election. But, as argued here, it’s not the most central question. For decades, Pemex was trapped by institutions of the state’s making—largely because the state was living off Pemex. The results of this death-by-a-thousand-cut institutional approach meant Pemex was deprived of funds for reinvestment—upstream but definitely downstream; innovation never factored seriously into Pemex’s business plans; a series of regulations and institutions designed to increase transparency and curb corruption were woefully ineffective (Pemex remains by all accounts the most corrupt public institution in the country—a claim that, though widely repeated, is frustratingly difficult to prove). The constitutionally protected monopoly kept Pemex isolated from an industry that is inherently global, collaborative and changing. Consumption-side subsidies kept domestic oil prices unrealistic, but done so according to a political, not economic, logic. Taken together, it was only a matter of time before the relatively prolific and ‘easy’ oil that Pemex exploited started to run out.

Whether AMLO respects, reverses or drags his feet on energy reform will not address the depressing reality of Pemex’s multifaceted crisis. Unable to compete on an even-footing with other private firms yet lacking funds and human capital to assume the burden of exploiting Mexico’s offshore reserves or revive its long-neglected refining capabilities, what awaits Pemex behind either door #1 of competition or door #2 of protection isn’t promising. Regardless of what AMLO ultimately chooses for the sector, Pemex will be in big trouble.

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