A New Mexican Revolution: Energy Reform

Courtesy of The Economist, a look at the potential of Mexico’s energy reforms to transform not just the oil & gas business but the whole of its industry, if not derailed by politics:

RECRUITMENT flyers are being handed out in the main square of Los Ramones, a once-sleepy town of tumbleweed and spit-and-sawdust bars 63 miles (100km) south of Mexico’s border with the United States. The call is for workers to start building the second stage of a gas pipeline heading south towards central Mexico, even before the first stage of the pipeline has been inaugurated.

The Los Ramones pipeline is the spine of a proposed 10,000km natural-gas transport network that could lead the transformation of Mexico’s energy industry. When gas starts to flow down from Texas to Los Ramones along stage one of the pipeline, on December 1st, Mexico’s gas market will be physically plugged in to that of the rest of North America for the first time. Emilio Lozoya, the boss of Pemex, the state oil company, points out that this means Mexico will start to benefit from the cheap shale gas that has boosted the prospects of all manner of businesses north of the border.

The implications of this alone could be profound for Mexican industry. About a fifth of the country’s power is now generated with dirty and expensive fuel oil which, excluding subsidies, makes the cost of electricity to industrial users 75% higher than in the United States. A greater supply of cheap gas coming down the pipes, coupled with a recent liberalisation of the electricity market to encourage the building of new power plants, could start to drive down power prices for industrial users within two years, officials say. That could make Mexico’s most buoyant export businesses, such as carmaking and aerospace, even more competitive.

Yet this is just one part of an energy revolution that is set to sweep Mexico now that its constitution has been changed, and enabling laws have been passed, to end Pemex’s 76-year monopoly on oil and gas production. All aspects of the energy market are being opened up. And a country with huge potential reserves—including extensive shale beds that mirror those across the border in the United States, albeit with more legal obstacles—is poised to start exploiting them more efficiently.

In at the shallow end

On or around November 15th the government plans to start the process of inviting private oil companies, domestic and foreign, to bid for the first new exploration blocks, in shallow waters off the Gulf coast. By March next year the global oil majors will get their first glimpse of the tender process for some of the juiciest prospects of all, the mostly untapped deepwater sites in Mexico’s part of the Gulf. “Round One” of the tendering process will also include a number of onshore exploration blocks (see map). The government hopes that over the coming four years the successful bidders in this round will invest about $50 billion in the blocks they win.

Besides being able to bid for oil- and gasfields, and to build electricity-generating plants, private firms will be freer to invest in pipelines, ports and other infrastructure—something that cash-strapped Pemex has long failed to do. If all goes to plan, the influx of capital and the fall in energy costs should boost productivity and profits across Mexican industry, lifting the country’s hitherto anaemic growth rate—the main objective that President Enrique Peña Nieto had in mind when promoting the energy reforms.

Foreign firms are impressed with the speed at which Mr Peña is pushing through reforms that were all but unthinkable just a few years ago, even amid political turmoil. “Mexico has really captured the imagination of the world energy sector,” says Enrique Hidalgo of Exxon Mobil, America’s largest oil company. However, potential bidders are still waiting for details of all the technical and financial requirements they will have to sign up for.

Private firms, domestic and foreign, will also be looking for indications that the government is serious about ensuring they can compete fairly against Pemex and another state energy behemoth, the Federal Electricity Commission (CFE). Pemex officials insist they are perfectly happy to see competitors come in: they will have enough on their plates reforming the bloated and inefficient company, and reversing its declining oil output.

The government is conducting a communications blitz to reassure investors that there is plenty of room for new entrants to prosper alongside the two state giants, given the huge amount of untapped reserves the country enjoys, the dire need for new infrastructure and the strong demand for cheaper gas and electricity. The various regulatory bodies that oversee the energy business have been given new mandates to prevent market dominance, notes Francisco Salazar, the head of one of them, the Energy Regulatory Commission. And the national antitrust agency has been given the power to intervene in energy markets.

However, Mexican business leaders wonder how easy it will be for the two state giants to shake off their monopolistic mindset. “The risk is that you think you have a level playing field and you find yourself against two Samsons,” says Jaime Williams of the Business Co-ordinating Council, a lobby group.

Officials are also trying to dispel three further clouds of doubt that have been cast over the energy reforms recently. The first is the falling oil price. Pemex officials argue that this may even prove an advantage for Mexico, since its new oil will be relatively cheap to extract. Many of the new exploration blocks will have total costs of perhaps $40-45 dollars a barrel, they say, comfortably below the $77 a barrel at which Texan crude was trading this week. Global firms may thus lose interest in more costly projects in other parts of the world, and turn their attention to Mexico. Even so, if crude prices keep falling, some of Mexico’s costlier deepwater and shale-gas prospects may begin to look unattractive.

The second area of concern is violence and lawlessness. These have come back into the spotlight following the murders in September of 43 students in south-western Mexico (see article). Jesús Reyes Heroles, a former head of Pemex, notes that global oil companies are used to coping with such risks, though there may now be more attention on potential security threats in some oil-rich states, such as Tamaulipas and Veracruz. And, of course, many other new oilfields will be out at sea.

A third is transparency. Mr Peña has done himself no favours on this score: it emerged this week that he is living in a home owned by a businessman who has bid for big government contracts. The energy-bidding process will be overseen by a variety of ministries and regulators, which should help promote openness—though it may also promote bureaucracy.

Even if Mexico’s energy revolution is more of a slow-burner than the government hopes, it has the potential to create large numbers of jobs—with luck, at least some of them in the country’s strife-torn south. As its new pipelines eventually reach across not just the northern border but the southern one with Guatemala, they will bring cheap energy to Central America too. For all Mr Peña’s current political problems, the risk of his energy reforms being undone looks slim, and the prospects for businesses across the country, and perhaps the whole region, are set to brighten.

This entry was posted on Monday, November 17th, 2014 at 5:26 pm and is filed under Mexico.  You can follow any responses to this entry through the RSS 2.0 feed.  Both comments and pings are currently closed. 

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