Mexico: 2015 Will Still Be a Tough Year

The success of the Peña Nieto administration in passing a law for energy reform, as well as passing the secondary laws for implementing said reforms, is probably one of the most important moments in recent Mexican history. We wrote several years ago that Mexico needed a “game changer” and that if it could be done, it would be the Institutional Revolutionary Party (PRI) implementing that change, which is now back in power.1 However, as is often the case, reform only occurs when there is no other alternative and the Mexican petroleum sector seems to have reached that stage, as measured by the dwindling petroleum production.

Although the energy sector reform is a momentous event in Mexican history, the problems for the sector, and for the economy are not over. That is, investment in petroleum exploration and production takes time, a lot of financial resources and is a long-term investment. Turning around the current decline in the landscape for petroleum production will take several years, if not decades, and many billions of dollars. Furthermore, Mexico is calling on foreign investment for this effort of revitalizing the petroleum industry’s growth prospects. Thus, investors need to feel comfortable with the reforms such that they will be willing to commit billions and billions of dollars in investment over the next several years. At the same time, they need to be confident that a new government would not undo what the reforms have done and since Mexico already expropriated foreign capital in the petroleum industry in the past, it will not to be easy for investors to believe that the current process is something that will not be reversed in the future. At the same time, there is still one of the major political parties, the Party of the Democratic Revolution (PRD), who opposes the opening of the sector to private and foreign capital. This means that, in principle, there is always the possibility that if the PRD takes power in the future it could undo the changes. The good news for investors is that even if the PRD would like to revert the advances in the opening of the Mexican petroleum sector, the PRI and the National Action Party (PAN) will not support such changes. This provides some reassurance that the recent changes are here to stay, unless, the PRD becomes an absolute majority in the Mexican political system, which is highly unlikely.

Furthermore, the transition from the current oil-monopoly-dependent fiscal system will also be a difficult one, as the government adapts to the new constraints on fiscal revenues born out of the partial-privatization of the petroleum industry. If this were not enough, the effectiveness of the tax reform is still not clear, which will make the transition even more uncertain.

Petroleum Production and Exports: On a Weakening Trend

Subsequently, Mexican petroleum production peaked in 2004 at close to 3.5 million barrels per day and has not stopped declining. Perhaps this is the reason the political system has finally been able to change the fate of this important economic sector. Petroleum production has come down about 30 percent from its peak, to close to 2.5 million barrels per day (Figure 1). One hundred percent of the drop in crude has been due to a decline in heavy crude production

Heavy crude production also peaked in 2004 at 2.5 million barrels per day and was down to 1.2 million barrels per day in October 2014, a 50 percent drop from its peak. 

More than 40 percent of Mexican petroleum production is exported as shown in Figure 2, so the petroleum sector is a large source of foreign exchange for the country. Total exports of petroleum represent between 10 percent and 15 percent of the country’s total exports of goods. Furthermore, the Mexican petroleum trade sector remains in surplus. This surplus represented an inflow of $40.3 billion dollars in the past 12 months to September 2014. As a way of comparison, the petroleum surplus in 1993 was only $2.2 billion. Thus, even with dwindling petroleum production and due to the increase in the price of petroleum, the petroleum sector remains a strong contributor to Mexico’s economy and foreign reserves.

In the 1980s, almost 60 percent of petroleum production was exported. Today, that number is approaching 40 percent. However, if we look at the countries buying this petroleum, it is clear that the U.S. shale revolution is not only affecting Saudi Arabia and Venezuela, but it is also affecting the Mexican petroleum sector, and especially, petroleum exports to America.2 Figure 3 depicts the trajectory of Mexican export to America. Crude oil exports from Mexico to America started at about 70 percent of total petroleum exports at the end of the 1980 and remained close to 85 percent to 90 percent during the 1990s and up to 2011. Since then crude exports from Mexico to America have dropped close to the 65 percent to 75 percent range. Interestingly, this also coincides with the surge in U.S. petroleum production from shale. This means that the prospects for Mexican petroleum exports to the American markets do not remain positive if the U.S. shale revolution continues at the current pace.

Furthermore, the latest drop in petroleum prices is another challenge for petroleum and energy sector reform. If the expectation was for a large influx of private/foreign investment in the petroleum sector in Mexico, then the recent collapse in the price of petroleum will probably bring down those expectations. Furthermore, although the Mexican government has been able to temporarily shield the Mexican petroleum sector, and thus fiscal revenues, from the strong decrease in petroleum prices due to its policy of hedging the price of petroleum, the medium- and long-term prospects will likely dim if the spell of current weak petroleum prices remains or if it deteriorates further.