The economic transformation brought on by President Enrique Peña Nieto’s energy reforms are expected to impact more than Mexico itself. Different countries, including the United States, welcomed the changes, especially as they allow foreign investment in energy sectors after more than seven decades of nationalization. However, while opening many doors to Mexico’s northern neighbor, California especially believes that it will benefit the most from Mexico’s unique opportunity due to its location and commercial ties.
In August, the Mexican President and California’s Governor Jerry Brown shared the stage to discuss different aspects, mainly business opportunities. Peña Nieto’s visit was expected after Brown traveled south on a trade mission in July, accompanied by many business representatives and lobbyists who eagerly paid to tag along. State energy officials are quite optimistic about these visits, especially after the president signed legislation to facilitate investment and development in both the electricity and oil and gas industries, and considering the high energy potential of the country. “These energy reforms significantly alter the structure of Mexico’s energy industry,” they said. “California’s innovative policies send a clear signal, provide incentives and generate market demand.”
California Energy Commission (CEC) Chairman Robert Weisenmiller and the California Governor’s senior adviser Michael Rossi believe that California has many companies which can help Mexico effectively carry out its reforms while reducing emissions and promoting the use of renewable energy sources. “By doing so, California and U.S. energy companies will create more jobs and tax revenue on both sides of the border and build an even stronger economic partnership,” Weisenmiller and Rossi said. Mexico has made a plan to reach 35% of electric generation with clean energy by 2024, and so opportunities abound for developers and technology companies.
Having strong ties with Mexico is also important for California due to trade. The Latin American country is the state’s largest export market. In addition, two-way trade between both reached more than $60.1 billion in 2013, a number which Weisenmiller and Rossi believe would grow now that both regions are closer than ever. “The energy reforms in Mexico allow for this collaboration to continue and result in greater economic growth and the achievement of climate and clean energy goals on both sides of the border.”
Energy and trade relations aside, the electronics industry at both ends is bound to expand in the future. While Californian companies build the components of cellphones, computers and other electronics, it is actually Mexican factories that assemble the final products. International trade advisor Jock O’Connell from Beacon Economics pointed out, “Largely because of the very high cost of doing business in California, we don’t make an awful lot of consumer goods. It tends to be stuff that goes into stuff, the components that go into more complex products.” This expansion is inevitable as Mexico’s workforce has grown more skilled. In addition, after recent Chinese government crackdowns on American companies, many are expecting California to limit its focus on trade with China to concentrate on its new Mexican ties.
Though California seems to be the most eager for ties with Mexico, the United States as a whole would benefit from its southern neighbor. Despite dealing with migration and drug issues, the U.S. cannot deny that Mexico is the world’s eighth largest producer of automobiles and fourth largest IT exporter. It is also growing into a world-class aerospace and electronics manufacturer, a feat possible due to the United States’ support and exports.
With so much to offer, California and other states are bound to update their views of Mexico. The Golden State has already taken a positive step during Brown’s trade mission by striking an educational exchange agreement, which is a first of its kind between the Mexican government and an individual U.S. state. However, this is just one step in a longer journey that would result in stronger ties between the neighbors now that Mexico has evolved into a willing and able economic partner.
Last visit of Eric Garcetti, LA Mayor brought a share of the new Mexico City airport (US$9 bn) to Parsons Corporation, one of the LA Firms that came with economic mission. So, the question is how far California and Mexico want to be integrated.
California Green Road Sign and Airplane Above with Dramatic Blue Sky and Clouds by Andy Dean Photography
Mexico’s lawmakers have approved new and historic measures which will be opening the energy sector to private investment. The Mexican oil sector had previously been a state monopoly for over 75 years. Mexican President Pena Nieto made liberalization of the energy sector, among others, a central part of his platform when he became President. At present, Mexico is the world’s 9th largest oil producer.
In the next 6 months, details of the tenders will be made available by Mexico’s energy minister. There will be between 30 and 40 zones where private companies will be able to bid in the first tender. As has been reported widely, Mexico has an enormous, untapped oil reserve. The first round of public tenders will likely take place in early 2015.
Royal Dutch Shell, ExxonMobil and other foreign oil companies are reportedly interested and actively monitoring the recent legislative activity surround the proposed tenders.
As the new law outlines, foreign and private domestic energy companies will be permitted to explore, produce and refine oil. In 1938 Petróleos Mexicanos (Pemex) was created to perform these duties and has since done so exclusively. The new regime is the first time ever the Mexican government has permitted foreign or private energy companies to participate in this work.
Zepeda told news reporters that no big surprises should be expected from the tender process. That Pemex’s requests for some biddings to be reserved for its exclusive tender – will not be. In particular, where there are areas that Pemex does not have a demonstrated expertise – the government will be seeking foreign experts. Deepwater and unconventional drilling and exploration are some examples.
In the future, Mexico’s Congress will decide on further tenders. They will retain the right to award or not reward certain areas for public tender in the future. Mario Gabriel Budebo, a former hydrocarbons undersecretary, told media reporting on the matter that any new law should clearly spell out what criteria would be useful for those future tenders. In particular, he cited the need for clarity in the areas of licenses, profit or production-sharing contracts
After the initial tenders are completed, Mexico’s Comisión Nacional de Hidrocarburos (CNH) will administer annual tenders aimed at exploiting the approximately 115bn barrels of oil (equivalent) that is estimated that Mexico contains and that Pemex is unable to develop.
Zepeda told reports that the tender is likely going to take place next summer. And that “Blocks could range from 150 sq km for shallow-water fields to up to 500 sq km in deep waters and as big as 1,500 sq km in virgin areas.”
Despite these sweeping changes to the energy sector, the Mexican economy is predicted to grow at 2.7 percent this year – a slower growth level than what many had hoped for. As a result, Mexico’s President, Enrique Pena Nieto – has seen his popularity dip. Despite this, he promises to continue to focus on reform – and it appears clear too, that despite any political developments in the future, it’s likely that Mexico’s’ economy has been permanently changed to one open to the world.
Japanese Prime Minister Shinzo Abe ad Mexican President Pena Nieto have agreed to work together to help secure a twelve-nation agreement on the Trans-Pacific Partnership (TPP), as La Prensa reported last month. The TPP is an ambitious proposed treaty that would solidify trade ties between nations across the Asia-Pacific region – from North America, South East Asia, Latin America and North East Asia. Apparently, the negotiation also included issues related to members of the Pacific Alliance like Colombia, Chile and Peru, an economic block that Mexico joined to promote common investments through cooperation mechanisms.
As was reported by Fox News, the accord has “hit a snag…due in large part to the Japanese government’s desire to maintain its barriers to farm imports”. Peña Nieto’s administration, [however], has expressed confidence that the ambitious trade agreement will be signed before year’s end.
But this complex treaty was not all that was on the agenda when Abe visited Pena in Mexico at the end of last month. No, the leaders of Japan and Mexico signed 14 cooperation agreements covering oil, education, health, agriculture, renewable energy and environmental protection.
Both leaders also agreed to revisit and strengthen the bilateral economic association agreement the two countries signed ten years ago.
The Japan-Mexico economic relationship
Japan is Mexico’s fourth-largest trading partner. Among Asian countries, Japan is Mexico’s second largest trading partner behind China. Nearly 1,000 Japanese companies operate In Japan – with 20% of them having only just recently arrived in Mexico. As Fox News reported: “Peña Nieto noted that bilateral trade has risen by 64 percent since then and totaled nearly $20 billion last year.”
Fox News reported President Nieto as having said of the future of Japan-Mexico trade ties: “’There will be more academic exchanges, greater access to the Japanese market for small and medium-sized enterprises, a greater push for renewable energy and the development of sustainable agricultural models.’” Reporting further that Prime Minister Abe referred to a “’shared commitment to spur collaboration and investment promotion in the oil and shale gas area.’”
While no mention of Japanese investment to auto industry was made, Mexico is becoming a strategic hub for these Japanese auto firms, which had a combined 32% market share in the US during 2013. From official reports of Q1-2014, 122 Japanese auto firms invested $4,3 Bn representing 12.7% of total auto investment in Mexico.
While the trade ties between Japan and Mexico are envisioned to be broad based, one of the most important reasons Prime Minister Abe visited Mexico was the 2013 energy market liberalization, which ended Petroleos Mexicano’s (the government’s oil company) monopoly. The liberalization allows private companies to develop crude reserves for the first time since 1938.
During the Abe visit, an agreement between Mexico’s state oil firm Pemex and Japan’s development bank, and another between Pemex and the Japan Oil, Gas and Metals National Corporation. These agreements will see Japan able to import energy from Mexico at a time when it is in much need of these resources.
The 2011 Tohoku earthquake in Tsunami has placed strain on Japan’s domestic nuclear energy resources as the tragedy hastened the closing of many of the countries power plants.
In particular, Japan has a particular interest in Mexico shale gas, but no specific plans have been made to import that gas yet, Yahoo news reported. Underpinning this interest is the ease with which that gas can be imported versus more challenging import routes. “The American gas Japan currently buys comes from the eastern United States, and must be shipped through the busy Panama Canal.”
The Mexican Eagle Ford
The Eagle Ford Shale is considered the largest economic development in the history of Texas, with a USD 60 billion impact estimated for 2012 alone and over 115,000 jobs created in 20 nearby county areas. It is also ranked as the largest oil and gas development due to the USD 30 billion spent in developing the play in 2013. With a record-breaking rate of 4,000 barrels per day of oil, the Eagle Ford play has put South Texas on the map. However, whereas the lights can be seen from the surface-level gas flares and rigs in the area, the Mexican part of the shale is engulfed in darkness.
The Mexican share of the Eagle Ford Shale has hundreds of mile forming the Burgos Basin, and bear the opportunity of thousands of wells to boost the economy. While the American side has over 5,400 wells, Mexico has only attempted 25. It is expected a change from the secondary legislation that is under final discussion at Congress now.
The Effects of the Mexican Energy Reforms
Initiated by President Enrique Pena Nieto, the energy reforms will open the Mexican oil industry and private foreign investment sector after over seven decades. As a result, foreign investors are having a serious interest in the country, and could bring along new technology, expertise, and risk assessment tools that state oil monopoly Pemex has failed to introduce in its operations. Though lawmakers are currently working on the details of the reforms, U.S. oil and gas companies as well as others from across the world are optimistic about being able to bid on projects by the end of 2014 and initiating projects even in some of the country’s most violent areas in 2015.
If all goes as planned, Mexico can easily become a large net importer of oil in a few years. Pemex predicts that the formation holds approximately 60 billion barrels of oil, which is more than the volume the country has produced since 1904. Natural gas especially is expected to be plentiful; a 2013 survey by the U.S. Energy Information Administration showcased that Mexican shale gas reserves were the world’s sixth.
Unfortunately, despite the country’s rich resources, its demand for electricity and pipeline infrastructure has forced it to depend on imported gas. At certain parts of the country, the prices of natural gas can reach four times as high as those in the United States. Therefore, in addition to countering this issue, the shale’s resources have the power to help the country’s economic and energy development and ensure its self-sufficiency when it comes to its fuel needs.
Finally, due to the lower cost of gas, Mexico can generate energy for less, empowering its manufacturing and assembly plants and helping them compete with China. According to Javier Trevino (PRI), the Mexican Congress’ head to the energy commission, “This is critical to the re-industrialization of North America. Mexico needs to develop these resources, or else we’ll be left behind.”
How the Reforms will Benefit Eagle Ford Shale Producers
The American producers will get numerous opportunities to start tapping into the Mexican side of resources. With Congress currently taking the necessary steps towards creating laws which complement the reforms, numerous organizations have started applying to the Federal Energy Regulatory Commission (FERC) to build border-crossing pipelines from the U.S. side of the Ford Shale to Mexico.
Columbia Pipeline LLC has already filed an application to construct a pipeline from Texas to help with generating power in Mexico. The company, which is a San Antonio based unit of Howard Midstream Energy Partners, has been collecting gas and continuously working on the infrastructure which Eagle Ford producers depend on.
“Howard Energy’s gathering pipelines are connected, either directly or indirectly, to significant supplies of gas produced in Texas…The border crossing facilities will…meet the needs of the expanding electric generation and industrial markets in Mexico. As such, the border crossing facilities will expand the market for domestically produced gas…will further national economic policy by stimulating the flow of goods and services between the United States and Mexico, in the process improving our international balance of payments,” said the company’s official.
Also following in the same footsteps is Kinder Morgan Inc., which has proposed the Sierrita Pipeline and made plans to connect it with natural gas transmission channels towards northern Mexico. The pipeline will connect El Paso Natural Gas Co’s mainline at the interstate system in Arizona to a point near the international border at Sasabe. “Sierrita Pipeline will serve new demand for gas transportation by MGI Supply Ltd. delivering natural gas to the border crossing facilities and on to Mexico; Sierrita’s services will not replace any existing services by other pipelines,” FERC announced.
Issues Which Should Be Addressed First
There are a number of issues which Eagle Ford Shale producers will have to take into consideration before they can venture into the Mexican oil and gas market. The first of these is the less developed Mexican infrastructure. Pipelines, rail and roads need to be taken care of and improved to facilitate production and allow raw materials capital equipment to make its ways from South Texas.
Another problem which Ford Shale producers will need to take care of is the security factor. Due to the constant drug violence in Mexico, especially around the borders, oil and gas producers tend to hesitate about entering the Mexican energy sector. Luckily, President Enrique Pena Nieto has already been waging a drug war two months since he took office in 2013. “My government will continue mounting a real fight against the trafficking of marijuana and all other drugs.”
In addition, due to its proximity to Mexican shale oil and gas deposits, the United States will make the most of these resources. While many countries are interested in tapping into the reserves in Mexico, most of the expertise needed for this task will be from the United States. Therefore, the U.S. is bound to benefit more from the prospects for shale oil and gas exploration in Mexico since has a wide experience in fracking and exploring techniques. However, still some environment regulation is still in process to be decided.
The Bottom Line
Mexico’s oil reforms will open the country for international investors and oil and gas explorers, allowing them to take advantage of the rich reserves in different parts of the country, including the Eagle Ford Shale. Aside from the U.S. and Mexico, shale oil and gas exploration will take its toll on global markets. The shale’s businesses and producers will be able to tap into the shale boom, strengthening their position and establishing themselves beyond North America.
Mexican President Enrique Peña Nieto has revolutionized his country’s oil and gas industry, opening it for foreign investors after 75 years and taking strict action against the 20 years of production decline, political stagnation, and a slow, underperforming economy. With the constitutional reforms already approved and the Congress finalizing discussion to determine and implement secondary legislation, Mexico is gearing up for a new future. It could end this very week.
The Effects of the Reforms on Pemex
Petróleos Mexicanos (Pemex) was previously celebrated as a symbol of national unity; the people of Mexico went as far as treat the day Pemex was established as a holiday. However, the oil and gas monopoly burdened the country by becoming a large employer of unskilled labor.
In addition, as half of its revenues were paid to the government in the form of taxes, Pemex’s low income was not able to contribute much to the economy. In 2013, Pemex reported an overall loss of USD 13 billion and about USD 2.74 billion in the first quarter of 2014. Inefficiency and low revenues aside, Pemex became a nuisance as it interfered with the country’s politics, meddling with the government whenever possible. Therefore, change was necessary to bring the company and the economy back on track.
By liberating the market from Pemex’s hold and allowing foreign oil companies in, the national Mexican oil producer will receive the help it needs to start efficiently producing oil. The reforms will also spare the Finance Ministry from its duty to approve the company’s budget. In addition, selling gasoline, which was monopolized by Pemex, will now be open to competition.
This may come as a blow to Pemex, especially after being in control of Mexican oil for so many decades. However, the government is taking steps to ensure a little leniency towards its national oil company. Not only is the government proposing that Pemex pay it fewer taxes for the next ten years, but President Peña Nieto himself assured its 153,000 employees that they will not be losing their jobs.
Regardless, Pemex expressed its wish to control most of its operations. Despite acknowledging that it lacks the financial and technical requirements to make the most from its existing fields, its officials are demanding that they be in charge while private companies entering the market join them as junior partners. This has brought on the criticism of many in the oil and gas sector, including deputy energy minister Lourdes Melgar who said, “Pemex wants to eat all the cake, but it can’t. I think there will be gray areas where we will have to ask Pemex for more information and at some point tell them, ‘This one won’t work.’ ”
In order to boost Mexico’s production by 20% or approximately three million barrels a day come 2018, President Peña Nieto intends to separate Pemex from the government and make it function like a for-profit company. To give the company the help it needs to start oil exploration and production operations in 2014, the government will also provide USD 28 billion. Though it may seem like an unnecessary step since the government wants to weaken the company, it will actually open the opportunity to boost the competition level in the Mexican energy sector. Pemex may even become as successful as Brazil’s Petrobras or Columbia’s Ecopetrol.
Through these changes, money and expertise will be flowing through the Mexican energy sector. The U.S. especially will be interested in partnering with Pemex since it shares many reserves of shale gas and oil with its southern neighbor.
How the Reforms Affect Market Valuations
The Mexican stock market in 2014 may not be as strong as experts expected, but many investors remain positive as the market has been trading at a higher valuation than most Latin American markets. However, investors are cautious, especially since the economy is still recovering. Besides, the past year came with its set of problems, including adverse weather conditions, lower government funding, and financial distress reported by three of Mexico’s top homebuilders. This explains why the Mexican economic activity did not meet forecasters’ expectations and the GDP growth amounted to a mere 1% in 2013.
Complementing the energy reforms is Mexico’s fiscal reform, which has affected both companies and citizens. Around the end of 2013, before the tax reform was implemented, corporations hesitated before investing and hiring. However, things have changed in 2014 and companies are following the new fiscal rules and higher taxes. Similarly, individuals are starting to slowly embrace healthier habits as high taxes were levied on sugary, high calories foods and drinks. Their spending habits will also recover near the second half of 2014, which is when the true effects of the new rules will be noted.
A Look at the Risks Facing Investors
Investing in Mexico is not that difficult, especially since the country flaunts the lowest banking penetration in Latin America. Experts believe that the financial sector will help boost the economy and ensure potential growth in consumption. However, as is the case in any form of investment, there are numerous risks which can lead to devastating consequences including loss of principal. Foreign securities are especially most susceptible to currency fluctuations and economic and political uncertainties.
Since the energy market is one of the emerging ones in Mexico, the risks associated with it are plenty. For starters, the lack of legal, political, business and social frameworks will cause chaos in the market. Prices will grow more volatile and the market will show lesser liquidity. There may even be numerous trade barriers and exchange controls, all of which may affect currency rates and ultimately reduce returns. Therefore, the government should start establishing regulations quickly.
Corruption risks are also hindering foreign players. According to the Department of Justice’s Transparency International’s Corruption Perception Index, Mexico scored 34 out of 100 with 100 being a corruption-free country. Mexicans themselves admit this characteristic and even associate Pemex with it. However, even corruption is not deterring many large investors as they can always create a risk-based compliance program that is perfectly tailored to overcome risks.
The Bottom Line
As the reforms are still at a delicate state, Mexican opposition figures are constantly criticizing them. However, officials like the Mexican Secretary of Finance Luis Videgaray Caso believe that changes are never easy. “Making fundamental changes is always challenging,” he said. “There… [is] some resistance to change. Mexico’s energy sector has a lot of potential to create jobs and to lower the cost of energy to families and companies across Mexico. But for that, we need to have investment and we need to have technology that we currently don’t have,” he added.
However, opportunities will come Mexico in due time to those who follow and analyze in depth the reform.
Photo credit: PEMEX gas station by Alberto Esenaro