Frederick Pai Security, Trade and the Economy

Mexican Government Reforms Oil Industry

Mexican politicians celebrate the passing of the recent energy bill

The federal government of Mexico recently passed legislation that removed a state monopoly on oil and natural industries. Given the considerable size of Mexican oil reserves, which includes numerous onshore oil fields as well as vast deep sea prospects, experts predict that this trade liberalization will significantly increase the international oil supply which will ultimately reduce oil prices. Although cheaper oil prices and petroleum products may be welcomed by Canadians, many Canadian firms are concerned about the potential of increased competition from Mexico.

In 1938, the Mexican oil industry was nationalized by  President Lazaro Cardenas when he seized Mexican oil fields from British and American petroleum firms. Cardenas passed protective legislation in the Congress and since then, Mexico’s constitution forbade foreign companies from mining, refining and distributing natural oil and gas on Mexican territory. The oil industry was entirely controlled by the state corporation, Pemex, until recent reforms which were passed on December 13th, 2013. Many Mexicans tout the latest developments as the most significant economic legislation since the creation of NAFTA (North American Free Trade Agreement) in 1994. NAFTA and the new legislation share the underlying philosophy of improving Mexico’s economy by attracting foreign directed investment to spur domestic growth.

For much of the 20th century, the Mexican oil industry was entirely controlled by Pemex.

The legislation is intended to fix the economic problems that arose from Pemex’s institutional monopoly. Without free market competition, Pemex incurred large inefficiencies over the past decades. In a competitive free market, foreign oil companies would invest heavily in research and infrastructure to streamline oil extraction in order to beat other firms. However, under Pemex, technology has become outdated and Mexico suffers from a severe lack of infrastructure such as pipelines and refining facilities. Furthermore, Pemex has been criticized for corruption. As many as 80% of Mexicans associate the company with lack of transparency and an exploitative executive. Experts estimate that to fully exploit the Mexican oil fields, Pemex needs to raise 60 billion dollars annually. As a state owned company, however, Pemex could only raise 25 billion dollars a year without foreign investment. To exacerbate the issue, state control of Pemex meant that any request for funds, regardless of size, had to pass through the Treasury resulting in bureaucratic delays. Mexican oil production has diminished by 25% since 2004 and is currently sitting at 2.5 million barrels a day, compared to 3.3 million barrels in 2004. In contrast, global oil production has actually increased slightly since 2004.

The privatization of the Mexican oil industry will be a large improvement upon Pemex and several foreign companies have shown keen interest to invest. American investment bank JP Morgan Chase & Co estimates that the reform will increase foreign investment in Mexico by as much as 15 billion dollars a year by 2015. In return, foreign companies will gain access to the estimated 60 billion barrels of crude oil onshore as well as the 27 billion barrels in deep sea deposits in the Gulf of Mexico.

Foreign companies still face significant obstacles. The reforms still need to pass through state legislatures before oil extraction can begin. Although this is unlikely to be a significant problem as most states are in favor of the recent reforms, it may cause delays as details are negotiated. A more significant source of opposition comes from the indigenous communities who live near or on oil fields. Furthermore, tax rates, royalties, and licensing processes are yet to be determined and negotiations will take time. Another problem is the lack of infrastructure at potential oil fields. Pipelines and refining facilities take many years to construct. Given these obstacles, it is difficult to predict when Mexico will enter the markets as a competitive producer of oil. However most analysts believe that Mexico will become a major oil producer and some believe that production will surpass Canada by 2025.

Mexico’s entrance into the oil industry may adversely affect Canadians. A large increase in the oil supply will diminish oil prices and reduce revenues of Canadian oil producers. Given that the US monopoly on Canadian oil allows them to buy the resource at below the world market price, competition from Mexico can affect Canada more than other oil producers. Although Canadian oil companies will have the opportunity to compete for oil fields in Mexico, many expect Canadian firms to be edged out by foreign energy giants such as BP PLC and Exxon Mobil Corp. On a more positive note, the recent reforms have pushed up the value of the Mexican Peso and many predict that if Mexico is to become a major oil producer, their currency will become more valuable. This can have a positive impact at the macroeconomic level and help improve Canada’s trade balance with Mexico.

Although the recent legislative reforms are good for Mexico and most of the world, as a nation reliant on energy exports, Canada has reasons to be concerned.

Frederick Pai
Frederick Pai is a Junior Research Fellow at the Atlantic Council of Canada. He is a third-year student at the University of Toronto where he is pursuing an Honours Bachelors of Arts in Political Science and Economics. His interests include Canada's role in international trade, Canadian foreign policy and the politics of South East Asia.