Economist Intelligence Unit: Mexico oil and gas, Hot potato

There are many recipes for bringing the private sector into Mexico’s oil industry, but few are palatable.Mexico’s president since December 2012, Enrique Peña Nieto, is moving ahead with his promise to bring private capital into that bastion of state ownership, the oil industry. A disappointing auction at a crucial oil basin this month bolstered the case of those who argue Mexico must carry out reforms to entice in foreign firms and raise production. But as Mr Peña Nieto seeks to convert election slogans into policy he faces an extremely difficult task.

Globally, dozens of approaches to oil privatisation have been tried in the past couple of decades. Yet Mr Peña Nieto’s dilemma might be likened to that of a cook who must serve a single dish to two people with totally different tastes: he must satisfy reserves-hungry international oil companies, as well as Mexicans allergic to the merest scent of privatisation. A recent survey found that two-thirds of his countrymen oppose any overseas investment in the oil industry.

Emulating Petrobras or Ecopetrol?

Entrenched opposition did not stop Mr Peña Nieto two years ago raising the possibility of applying the “Petrobras model” to its state oil company—and biggest corporation—Petróleos Mexicanos (Pemex). In the 1990s, Brazil made its national oil company officially independent, sold shares to the public and strengthened regulators’ powers, bringing Petrobras under the same transparency laws that govern other publicly traded companies. The firm became the stock market’s darling. International financial investors and oil companies alike renewed their interest in this emerging market. But the tide has long since turned.

Petrobras has been made to float extra shares, diluting the holdings of unimpressed investors. Regulated motor fuel prices have been widely criticised for limiting the company’s income. Petrobras stock now trades at an eight-year low, while the laggardly pace of development at big offshore fields frustrates foreign firms.

An arguably more attractive model is offered by Colombia’s national oil company, Ecopetrol. Whereas Brazil has never really cut its state champion loose, the Colombian government has treated its much less as a tool of policy. The contrast is reflected in the pair’s publicly traded shares: Petrobras’s have lost about 70% their value during the past five years, while Ecopetrol’s have surged by an even greater margin.

Production-sharing agreements

The other major means available to encourage private-sector participation in the oil sector is to turn to production-sharing agreements (PSAs). The specific form of these varies from country to country: tax burdens differ widely, as do local procurement rules and privileges for local investors. But the basic idea remains the same: private companies bear the risk of exploring for hydrocarbons in exchange for certain benefits. If they find oil and start pumping it, they typically receive all the income until they have recovered exploration costs, and are guaranteed enough oil to cover taxes, royalties and operating costs. Further revenues are split with the government. It is a mechanism that has been tried and tested across the world—including in Mexico.

The country used PSAs for decades even after its 1917 constitution made hydrocarbons government property. PSAs were banned in 1958, but it is theoretically possible to reverse this legal change and return to the former regime. Indeed, Mr Peña Nieto said recently that he wants to bring more private investment into specific fields, indicating he may indeed be considering using some sort of PSA.

This could build upon existing “integrated exploration and production contracts”, introduced in 2008. These reward service companies whose efforts help raise oil production. A further step would be to allow Pemex to “contract” international oil companies to drill in its stead. Doing so might allow Mr Peña Nieto to dodge accusations of carrying out treasonous privatisation and may only require minor legislative tinkering.

Venezuela’s use of an arrangement like this in the 1990s will give him pause for thought. The move enabled private contractors to revive declining oilfields. But some citizens, including prominent politicians, believed that the spirit of the law was being broken. A dramatic reassertion of state control over the industry followed in 2006-07.

Political problem

Either of the two main options, selling shares in Pemex or offering PSAs at specific fields, is certain to face constitutional challenges if adopted. But in the final analysis, the barriers are less legal than political, given doughty public and political opposition.

In this regard, Mr Peña Nieto could be tempted to borrow another trick from Venezuela. From 2006 onwards, the country’s now deceased President Hugo Chávez let foreign companies book reserves on their balance sheets for the first time—a huge concession from the socialist leader. But he did so under the cover of a blaze of nationalist rhetoric (and, admittedly, not without some theatrical nationalisations). He thus protected himself from opponents’ sniping.

What is less easy to imagine is the government drawing the lesson from Petrobras’s case that it must make Pemex truly independent. For any Mexican leader, giving up control of the country’s largest company would leave a bitter aftertaste—one that no amount of spicy Mexican sauce could mask.

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About Steven Bodzin

Steven Bodzin is a reporter. He blogged when he was a freelancer.

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