December 11, 2018
President Andrés Manuel López Obrador assumed office on Saturday December 1st after a historic landslide election in July. In the aftermath of the victory, then-president-elect López Obrador’s rhetoric and actions moderated, fueling cautious optimism that he would be pragmatic upon taking office.
Those expectations are proving to be short-lived. In his inauguration speech, President López Obrador laid bare his vision for the country, blasting the “disaster” and “inefficiency” of the neoliberal economic model, epitomized in the 2013 Energy Reform, while praising Mexico’s formerly state-led model.
Although broader economic policy is set for a leftwards turn, no sector is as exposed to the new political headwinds as energy. President López Obrador has been a vocal opponent of private energy investment for decades, criticizing the energy policies of the most recent administrations.
In his inauguration speech, he spent three minutes blaming the reform for falling oil production, higher fuel and electricity prices and the fragile states of the public energy company, Pemex, and the public utility, the Federal Electricity Commission (CFE) – issues that predate the energy reform and have their roots in an era of state control over the sector. His proposed remedy? Increase state control over the sector.
Resource nationalism is on the rise in Mexico. Despite the challenges, we believe that with the proper engagement strategies, companies will be able to navigate the country’s historical political shift. Mexican oil and gas could continue to be a growth play for domestic and global investors.
After a few weeks of cautious optimism following López Obrador’s election, markets have now turned jittery. Judging from the increasing frequency of asset selloffs in Mexico, investors have doubts that the new administration will ensure continuity of the country’s pro-business policies. While the stock market and the peso have recovered after each selloff, there is concern that the volatility, over the long run, will permanently damage value in those assets.
At least five warning shots have been fired, creating doubt on López Obrador’s intentions to rule pragmatically.
These signs all point towards an increasing level of political risk. And in no sector is this indicator being more closely tracked than in the oil and gas sector.
The debut of the new administration has created significant doubts over the possibility for continuity of the Mexican energy model. The 2013 Energy Reform opened all areas of Mexico’s energy market to private investment for the first time in nearly eight decades. The reform sought to revert declining production and lower energy prices by ending the inefficient Pemex monopoly and allowing more players in the sector.
Ideologically, President López Obrador long rallied against the reform on resource nationalism grounds. His rhetoric before the election and during the transition suggest that private players will be scrutinized and face volatile policies during his term. On one hand, the new president has abandoned previous rhetoric calling for an outright revocation of the reform via Congress or forced contract renegotiations. Nevertheless, he remains hostile to private investment in oil, despite recognizing that Mexico needs international investors accelerate economic growth.
While the reform has, up to now, delivered positive results in the number of blocks licensed and investment commitments, it must continue to be nurtured for it to yield its full benefits that transform Mexico. The country has a significant resource base that could justify some tolerance of the increasing above-ground risks. Nevertheless, the initial warning shots threaten to spook investors from seeking new opportunities, and they may move on towards additional jurisdictions in Latin American and beyond.
AMLO and his energy team have repeatedly commented that new licensing rounds will be suspended, reflecting their hostility toprivate investment in the energy sector.
A bill seeking to subordinate Mexico’s independent energy regulators, the National Hydrocarbons Commission (CNH) and the Energy Regulatory Commission (CRE), to the executive’s purview within the Secretary of Energy is a clear reflection of the new administration’sdesire to impose its statist vision on the sector
The premature resignation of the head of upstream regulator, CNH, reportedly under pressure from the new officials, removes akey advocate of openness in energy investment and implies a return to a statist model.
President López Obrador has long sought to build a refinery to lower gasoline prices, arguing that it would curb imports of US gasoline. The consultation, held in late November, resulted with an overwhelming 91.6% of voters choosing to build a new refinery in Tabasco, AMLO’s home state.
Nevertheless, a new refinery is unlikley to provide relief at the pump, but represents the new government’s intentions to increase its control over the downstream sector. It is also a pork barrel project for the president’s home state.
As of late October, Pemex’s total refinery utilization ran at 26%. Moreover, with Pemex’s production plummeting, there is doubt over how the new refinery will be fed with oil.
The president promises to freeze (in real terms) or lower fuel prices after prices at the pump rose in January 2017 as part of the outgoing administration’s plan to introduce market pricing.
Continuing to subsidize fuel prices would create additional fiscal strain amid President López Obrador’s ambitious spending plans. It is unclear if the federal government would subsidize Pemex or leave the state oil company to bear the cost of selling fuel for lower than its cost.
Self-sufficiency in energy and food was a recurrent theme in the campaign, and President López Obrador has proposed phasing out crude oil exports to increase domestic refining volumes. Concurrently, he has proposed reducing imports of US gas and fuel for fiscal reasons.
Reducing crude exports, which historically account for a third of public revenues, would severely impact sovereign finances. The suggested fiscal offset by lowering imports of US fuels would not make up for fewer crude exports. Meanwhile, reducing imports of US natural gas (the source of 85% of gas) would severely impact economic activity in all sectors.
President López Obrador has repeatedly promised to ban fracking for environmental reasons, even though it would be the fastest way to boost natural gas production and the most credible alternative to reduce dependency on US imports.
In addition to the specific oil and gas policies, there are likely to be highly burdensome environmental, labor, and social regulations that could make it difficult for companies to operate. This comes despite the new president’s promises to reduce red tape. Similarly, the proposed bill to require new mining concessions to have neighboring communities’ consent could be replicated for onshore hydrocarbons fields.
With an increasingly challenging political and regulatory environment, all signs point towards Pemex and CFE reclaiming the path towards even more marked dominance in all branches of the energy sector. Nevertheless, the new administration is aware of the private sector’s role in reaching the new president’s goal of rebooting oil production to 2.6 million barrels per day. As a result, the new energy team has stated that it will respect existing contracts. It has also, however, set the bar high, stating it expects to see the private contracts bear fruit to counteract the country’s falling production. The fact that, so far, the administration has ignored the decades-long trend of declining production and the length of oil and gas investment cycles adds additional pressure.
Even with this context, there is opportunity for the oil and gas sector to find common ground with the new administration. President López Obrador’s team is cognizant that a strong national private sector is needed to create jobs, generate tax revenue, and fulfil his ambitious campaign promises.
Despite the direction of these initial proposals, rapprochement with the private sector, specifically the oil and gas industry, should not be ruled out over the medium term as financial realities keep the new administration in check. Taking this into account, we believe there is room for the industry to advocate for broad policy continuity to preserve the policies behind Mexico’s energy opening alongside President López Obrador’s new vision for the sector.
Andrés Manuel López Obrador gets off to a rocky start after firing several shots across the bow of the private sector. Given its prominence and historical context, all eyes are turning towards Mexico’s oil sector. How President López Obrador deals with it will provide powerful signals for all the other industries to read.
Thus far, all branches of the hydrocarbons industry are braced for potentially tough policy shifts under the new administration. President López Obrador will likely reassert the federal government’s control of the energy sector by passing policies that benefit Pemex at the expense of private companies.
While resource nationalism appears set for a resurgence at the debut of the López Obrador Administration, Mexico continues to boast numerous opportunities across the panorama of the energy sector. However, capitalizing on these opportunities will only be possible by adopting public affairs and government relations strategies fit for the López Obrador era.
On one hand, companies will need to actively engage officials to help delineate concerns and propose solutions, but they will also need to think well beyond key decisionmakers and include influencers and broad swaths of the public. The possibility that more radical names or factions of the party seek to influence congressmen or state governments reinforces the need to build broad support among the public. Their legitimate concerns need to be assertively and transparently communicated, both individually and through industry organizations.
Central to achieving positive outcomes, of course, is finding common ground between the new administration and companies. Having objectives where both the government and companies benefit should strengthen officials’ willingness to cooperate. These can include development goals, such as building infrastructure or providing training, or they could be broader goals like creating jobs.
Finally, the development a coalition – among elected officials, opinion leaders, and NGOs – could make the difference in successfully engaging the new administration to achieve specific policy goals. In a scenario of uncertainty, integrated communications campaigns deployed by broad coalitions can make a difference.