A little over a month ago, President Peña Nieto delivered an energy reform proposal to the Mexican Senate. If passed, it will be the most significant change to the energy sector since the 1938 nationalization of the oil industry. The bill includes changes to both PEMEX and the electricity sector regarding private investment, enhancing PEMEX’s fiscal autonomy, and reorganizing its bureaucratic structure.
At this point, the proposals on the table are broad brush and mainly involve Constitutional changes, leaving important details to be worked out in subsequent legislation. Much depends on how this secondary legislation is written, so only a broad-brush analysis is sensible at present.
The private investment provisions in the president’s proposal have received the most attention from political forces and potential private sector investors alike. They would reform the Constitution to permit previously banned contracts between PEMEX and private investors – including foreign firms – to be involved in exploration, extraction, and transportation of oil, gas, and petrochemicals. The contracts would permit profit-sharing with two stipulations. Payments to the private sector would be made in cash, not in product, and the national content requirements for components produced in projects that fall under profit-sharing contracts would increase modestly.
The proposal doesn’t discuss shale or the deep-water reserves in the Gulf specifically, but these potentially large deposits are the likely rationale for reforms. Currently, Mexico does not possess the technology to access these reserves and needs the help of foreign companies, possibly from the United States or Brazil. Accessing these deposits is important because Mexico’s main proven oil fields have been in a fairly steep decline for a number of years. Not only could deep-water and shale deposits make up for lagging production, they could significantly advance Mexico’s economy and contribute to North American energy independence.
It is notable that the president’s reform proposal does not go as far as private companies had hoped. It would not give private companies ownership over oil and gas and it would not permit production-sharing agreements. But as Duncan Wood points out, there is a fair bit of nuance here. The proposal would remove Constitutional roadblocks for private companies to share the risks of exploration and production, meaning that future Congressional action could enable risk-sharing agreements with ordinary legislation that only requires a 50% + 1 majority.
One of the interesting elements of the reform package is the rhetoric surrounding it. Private investment in energy has been the third-rail of Mexican politics. The 1938 expropriation is viewed by most as a key act in fulfilling the State’s social responsibility to citizens, a responsibility that is written into the Constitution of 1917 with the blood of the Revolution’s martyrs. President Lázaro Cárdenas (1934-40) remains a major figure in Mexico’s political history and popular lore not only nationalized oil but because he founded the key predecessor to Peña Nieto’s party, the Institutional Revolutionary Party (PRI).
Typically, the image of Lázaro Cárdenas is used to defend oil against any foreign or private encroachment. And indeed, the former president’s son, Cuahutémoc Cárdenas, founded the leftist Party of the Democratic Revolution (PRD) and has authored an alternative proposal that would continue to prohibit private investment and inject more government capital into PEMEX.
In an attempt to sell his proposal to the nation and undercut the leftist alternative, Peña Nieto has deftly argued that Cárdenas never intended to ban private and foreign investment in PEMEX. In fact, the possibility of both profit-sharing and production-sharing agreements existed in the Constitution from 1940 until 1960 when an amendment banned the practices.
A final proposal by the rightist PAN would move the needle the furthest toward privatization by allowing private firms to own concessions, book reserves, and compete directly with PEMEX. As a result, the president’s proposal sits in the middle of the three, making it the least unpalatable second-choice for legislators on the left and the right.
The reform appears likely to pass. It will necessitate a change to Articles 27 and 28 of the Constitution and so requires a 2/3 majority in both houses of Congress as well as approval by more than half of the state legislatures. The president’s PRI does not have the votes on its own and will have to construct a three-party coalition, likely including the rightist PAN and the opportunistic so-called Green Party (PVEM).
Looking toward the future, four likely effects of the reform loom largest. First, are the reforms sufficient to bring private firms to the table? Only a small number of companies have the needed technological know-how, so whether they “play ball” or demand more (such as more profitable risk-sharing agreements) will depend on whether Mexico’s government can create competition between them. If they present themselves as a bloc and remain on the sidelines in hopes of winning greater concessions, Congress and the President will have to decide whether to deepen these initial reforms.
Second, will the reform break the Pacto por México between the PRI, PAN, and PRD that has essentially forged a standing agreement to pass major legislation? The Pact has overcome the inertia of Mexico’s fragmented three-party Congress that led to substantial policymaking challenges and a slow rate of reform during the past two administrations. Keeping the Pact together will likely require a logroll on fiscal reform. The PAN’s policy vision shares more with the PRI, so the PAN will likely not bolt from the Pact. The question then is about the PRD. If it gets a more progressive tax regime, including the current proposal to increase income taxes on higher wage earners, raise taxes on businesses, and stall the expansion of the regression value-added tax, then it may remain in the pact despite energy reform it dislikes.
Third, no matter whether the PRD accepts the logroll, López Obrador, the leftist runner-up in the 2006 and 2012 presidential elections, likely won’t. He has already spearheaded protests and these may continue. The oil workers union likely won’t be involved due to deep ties with the incumbent PRI, but Mexico City is home soil for the leftist PRD. As a result, the events could be massive and of long-duration. The administration has already endured large protests by teachers’ unions following the recent education reform. Theoretically, a wave of protests over various issues could unite opponents to the current administration and make it difficult to continue the fast pace of reforms during Peña Nieto’s first year in office.
Finally, the PRI may pay a cost for energy reform at the polls. Not only do more than 50% of citizens oppose increasing private investment in the oil sector, independent voters that have proven crucial in prior presidential bids are by far the most opposed. Voters are unlikely to feel any of the potential benefits of the reform for at least five years. An electoral backlash that favors López Obrador in the 2018 elections is not out of the question.