Will Mexico's Election Results Derail Energy Reform Agenda?

The historic and so far successful energy reform of Mexico apparently faces risks if the leading candidate for presidency, Andres Manuel Lopez Obrador wins the elections to be held on Jul 1. After almost eight long decades of state management, Mexico opened its energy market to foreign investors through five- year (2015-2019), two rounds per annum tender plans, which enabled the country to draw investment from oil-mammoths like Royal Dutch Shell PLC (NYSE: RDS-A), Chevron Corporation CVX, BP p.l.c. BP and others. It effectively ended the reign of the state-run oil producer Petroleós Mexicanos (Pemex) in Mexico.

Political Slugfest

Andres Manuel Lopez Obrador, or AMLO, who represents the MORENA party, is now around 20 points ahead of its nearest competitor after the first presidential debate opened last Sunday. His view regarding Mexico's energy sector is that of constrained freedom. He stated, "We're not going to sell crude oil abroad. We're going to process all the raw material in our country to lower the price of fuel." Notably Mexico is a major oil exporter and a huge portion of its supply reaches the refineries in the U.S. Gulf Coast, Asia, Europe and other places.

He is hopeful that the policy will enable his administration to stop energy imports, following upgrades of the existing energy infrastructure. Notably, Mexico imported processed petroleum oils amounting to $24.8 billion last year, a 37.5% year-over-year increase.

Andres Manuel asked the current President of Mexico, Enrique Peña Nieto to halt the upcoming auctions in July and September. The future of existing contracts will be uncertain if the import substitution policy takes place. We believe that overall investor sentiment will take a hit with these measures. Worse, it can drive investments away from the country and stifle growth of the sector.

The Failure of Pemex

Industry observers still believe that Pemex lacks the required technology as well as capital to develop onshore and offshore energy sources of Mexico. Production in the country dropped from 2005 onward under Pemex-rule. This makes AMLO's plans appear pretty risky. In fact, the state-run oil company's output declined 10% year over year to average 1.948 million barrel per day (MMBbl/d) in 2017. Crude exports fell 1.7% during this period. Moreover, the refineries under the state-run company produced 915,100 barrels of fuel per day last year, compared with 1.6 million barrels per day capacity, which shows inefficiency.

Importance of Reform

Following the reform, Mexico drew multi-billion dollars' investment. It could lead up to an output of 3 MMBbl/d by the end of the planned period, as predicted by the supporters of the reform. The reform could also bring down electricity rates in the country. So far, Mexico has awarded around 90 contracts, both onshore and offshore. The country raised about $100 billion from the auctions by the end of January. With nine oil and gas blocks, Shell has emerged as the leading player in the auctions held so far. Other winners in the bidding processes include Eni S.p.A. Eof Italy, Inpex of Japan, France's TOTAL S.A. TOT, Chevron and more.

Moreover, BP opened 100 retail sites in the country in 2017 and plans to open 1,400 more by 2021. The largest publicly traded oil company, ExxonMobil Corporation XOM opened its gas stations in Mexico in December, while one of the world's biggest independent oil producers – ConocoPhillips COP – showed interest in Mexico, post-reform.

Following the reform, Mexico now has the opportunity of not investing taxpayer funds for exploration and production. Instead, private capital from large-cap oil majors has assumed the risk while paying taxes and royalties to the government. The government can use its capital in other more important causes, like health sector. It also brings an opportunity for Pemex to benefit from the state-of-the-art technologies and the financial muscle of overseas players. 

Our View

There's a way through which both the country's energy sector and politics can benefit. While co-existence of reform and closed energy sector is nearly impossible, AMLO can go for another option, which includes contractual changes and more entitlements for Pemex. Although it may keep some investors at bay, still, it will make the reform, as a whole, more nationalistic, and fetch more home support.

Therefore, the upcoming election results will determine whether Mexico has got the ability, will and transparency to properly implement the safeguards and regulations of the country's nascent energy reforms, keeping in mind the interests of potential investors as well as the public.

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