The Pemex Door Has Opened

Mexican President Enrique Peña Nieto capped a year of reform with a final act that far exceeded expectations of the 47-year-old leader’s first year. Energy reform, passed by the Senate and Chamber of Deputies last week, will end a 75-year policy prohibiting private investment in the country’s hydrocarbons sector. Some estimate that the reform will add an additional 2 percent to Mexico’s economy by 2025.

Details need to be worked out, but expectations are that Mexico’s newly-competitive energy sector could catapult the world’s ninth-largest oil producer up to the fifth-largest in a decade.

The reform must still be ratified by a majority of the country’s 31 state legislatures. But that is a formality. The two parties that joined forces to pass energy reform are firmly in control at the state level.

Since nationalisation of oil in 1938, Mexicans have decried any whisper of a change in policy with shouts that “the oil is ours”. Oil has been to Mexico what Jerusalem is to the Middle East – intractable and non-negotiable. But state oil company Petróleos Mexicanos (Pemex) has seen its output fall for some time now, with crude oil production declining by about 1 million barrels per day in the last eight years. Pemex funds about a third of the national budget, which further raises the burden of falling production.

Other promising hydrocarbon deposits in Mexico, particularly in shale beds and deepwater wells, remain untouched because Pemex lacks the technology and financial capacity to profitably extract from these sites. While Mexico’s energy production remained stalled, other countries with the assistance of the private sector have learned to develop hard-to-reach resources efficiently, with less pollution and risk.

The government estimates the reform will lower energy prices, create over 2m jobs over the next decade, strengthen Pemex by making it compete on equal grounds with private companies, and provide Mexico with needed funding to invest in long-term infrastructure projects. Under the legislation, a new Mexican sovereign fund will be created, operated by an appointed independent board, to manage royalties and make investments in the country.

The reform will allow private investment through various schemes: profit sharing, production sharing, or in the form of licences. Mexico will benefit from new technology and financial and human capital to exploit its abundant energy deposits, not to mention the royalties it will receive. Foreign and domestic private investors will benefit from entering a market with plentiful energy resources.

Passage of the reform was far from easy. But the lost economic opportunities of inaction were far greater than the political risks of action. Still, Peña Nieto had to sacrifice his carefully constructed Pacto por México – an agreement among the three main political parties to work together on 95 initiatives – to pass energy reform. The left-leaning Party of the Democratic Revolution (PRD) pulled out in protest at the reform’s opening of the sector to private investment.

But the pact, which was anyway destined to end, has largely achieved what it set out to accomplish. The historically untouchable telecommunications industry is now open to greater competition, the education system can now break free from the control of powerful teachers unions, a tax reform will increase revenue, and political reform reverses a ban on re-election for legislators and mayors. Mexico is on the right track, with its list of achievements the envy of national legislatures that struggle to pass even the most rudimentary bills.

Now we move from politics to policy. The legislative success took a year. In 2014, the game shifts to the long-term need to build adequate regulatory supervision and long-term financial viability. After all, the constitutional reform lays out seismic changes in the rules of the game that could boost production by an estimated 1m barrels per day by 2025. Overseeing the transition from a 75-year monopoly to an agile, open market will require steady, long-term outlays and constant vigilance. Mexico needs technical capacity to regulate such a huge sector.

Foreign energy companies will wait to see the oil and gas terms that the government eventually develops. These terms must be mutually favourable to draw in the hoped-for investment. Transparency, clear rules, and effective regulations will be critical to success.

This is an historic moment for Mexico and, done correctly, the mechanics of energy reform will help further catapult Mexico as a leader on the global stage. The projected economic growth is good news for the nearly 50 countries with which Mexico has free trade agreements, especially the US, which supplies about half of Mexico’s imports.

Still, Peña Nieto must now get ready for the next act. The Mexican economy has performed below expectations this year; the Mexican people will want to see quick economic benefits in exchange for the energy reform. Those who opposed the reform will continue to fight it. Results must be delivered quickly – and be felt by everyday Mexicans.

Jason Marczak is deputy director and Peter Schechter is director of the Atlantic Council’s Adrienne Arsht Latin America Center, which published a briefing on Mexico’s energy reform on December 19.

Related Experts: Jason Marczak and Peter Schechter