Monthly Archives: October 2015

Mexico’s Crude Capitalism

http://foreignpolicy.com/2015/10/01/mexicos-crude-capitalism-latin-america-energy/?utm_source=Sailthru&utm_medium=email&utm_campaign=New%20Campaign&utm_term=Flashpoints

Mexico’s Crude Capitalism

The country is providing a model for a new Latin American energy policy. But will it work?

  • BY KEITH.JOHNSON
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Mexico’s Crude Capitalism

When, in 2013, Mexican President Enrique Peña Nieto announced a broad reform package that would end the government’s monopoly over the country’s oil sector, his argument was fairly straightforward: Foreign investment could be just the thing to reverse a decade of production declines and revitalize a state that has historically relied heavily on oil for its income. Dazzled by the promise of numbers, Peña Nieto suggested that, by wrenching open the long-closed sector, Mexico could attract more than $60 billion in investment within just a few years, while adding at least a percentage point to its annual GDP growth and creating 2 million jobs.

The president’s idea was a revolutionary one in a country whose modern identity was forged thanks to the nationalization of its black gold in 1938. Critics, unsurprisingly, were quick to argue that Peña Nieto’s reform was nothing less than a wholesale dismantling of Mexico’s heritage. But the president knew that, without a shock to the system, his country could soon turn into a net importer of oil. That meant giving up, at least in part, the keys to the energy industry.

Mexico, along with Russia, has long been a poster child for resource nationalism, or the tendency for governments to claim outright ownership of all mineral resources and to monopolize pretty much all parts of the energy sphere. Nearly 80 percent of global oil reserves are under the control of national oil companies, according to a 2007 report by the Baker Institute at Rice University, leaving relatively little energy in the hands of multinational corporations. Mexico’s southern neighbors in Latin America are no exception: Over the past decade or so, these countries have moved to nationalize their industries, undoing what progress came after a bout of liberalism in the 1990s. Although that has played well with populist publics, such moves have kneecapped energy-producing potential.

Now, Argentina, Brazil, and Venezuela have little choice but to track Mexico’s experiment closely, considering that they all compete for the same investment dollars and that Big Oil will go where it sees the best prospects with the best terms. What’s more, these countries have an even stronger, inescapable reason to follow Mexico’s lead: Resource nationalism is a long-term recipe for disaster.

Take Argentina. It has the world’s second-largest shale reserves but is currently a net energy importer after nearly a century of whipsawing between nationalism and an open market. Foreign capital created windfalls in the 1920s and 1930s, but greedy governments snatched back those oil wells in the 1940s, until production dwindled; they then returned, cap in hand, to wildcatters and oil majors just a decade later—a Groundhog Day pattern that continues today. Most recently, in 2012, Argentina lurched toward nationalism again, expropriating its former national oil company from Spain’s Repsol. Argentina now has the unenviable task of trying to lure foreign money and know-how to help tap Vaca Muerta (Dead Cow), a shale formation roughly the size of Belgium that it cannot develop on its own. The next wave of Argentina’s leadership is undeniably watching to see whether Mexico has found the formula to keep foreign investment steady and to maximize both production and the government’s cut.

Meanwhile, Venezuela has the world’s largest crude reserves, yet it too must import some basic fuel. For a brief period in the liberalizing 1990s, the government attracted foreign capital and boosted production. But in the 2000s, under strongman Hugo Chávez, resource nationalism returned with a vengeance; oil production in the country has fallen by about one-quarter from its peak levels in 1997. Much more than in Mexico, such decline threatens societywide economic and political meltdowns because Venezuela gets about 95 percent of its export earnings—and half of government revenues—from oil sales. The shrinking pie has imperiled social programs and has limited the country’s ability to import basic staples, such as toilet paper, and even to keep the lights on.

Of the Latin American producers, Brazil, given the discovery offshore almost a decade ago of massive oil fields, was expected to play the most significant role in meeting the world’s future energy needs. Yet, blinded by the allure of future riches, the state tightened its grip on the industry, inflicting restrictive terms on foreign investment—a misguided effort to get as much as it could while offering as little as possible. Foreign capital largely turned its back, and Brazil’s oil promise burned: Recently the country slashed its five-year oil-production targets by 1.4 million barrels a day, roughly half its current output. Mexico can show a better way forward by requiring, for example, less onerous terms on investment, thereby making it quicker and cheaper to turn prospects into gushers.

Mexico, of course, has also been crippled by resource nationalism. It coasted for years on the back of hugely prolific offshore fields discovered in the 1970s, but production at those fields peaked around 2004, falling by about three-quarters the following decade. That left Mexico with a bloated, inefficient state oil company that was responsible for a big chunk of the Mexican treasury but had little wherewithal to reverse the slide or to embrace new technologies.

So in 2013, when Peña Nieto proposed upending the energy industry, he managed to pass reforms without any real challenge in the legislature. Fast-forward to this July, when, for the first time in nearly 80 years, Mexico auctioned off some shallow-water tracts in the Gulf of Mexico to foreign firms; onshore tracts in northern and eastern Mexico will be awarded this winter.

Mexico didn’t offer attractive enough terms, however, and the auction in July flopped. As a result, the country has postponed the auction of deep-water blocks, while it tries to strike the right balance between enticing foreign firms and ensuring that enough revenue still makes it to the national treasury.

If successful—a big if—the president’s experiment could finally kick-start production in the Gulf of Mexico and the desert. And if companies like ExxonMobil can turn oil potential into oil reality without prompting another revolution in Mexico’s streets, other Latin American countries would almost be forced to follow—or watch tens of billions of dollars of potential foreign investment pass them by.

Of course, such change won’t be easy, particularly because global oil prices have recently tanked, dampening investment appetite everywhere. Then there are security threats from narcotraffickers, especially around Mexico’s potentially energy-rich northern fields. And while proximity to the United States is in many ways a blessing—the world’s best service companies are a short flight away—it’s also a curse: Why make a risky play south of the border when the U.S. shale revolution remains steady?

Even still, for Latin America’s once and future oil giants, there’s something to be said for being in the right place at the right time. Demand for energy, especially oil and natural gas, is shifting east: In 2013, for the first time ever, oil demand in developing countries (led by China) surpassed that of rich countries. At the same time, production is shifting west: Since 2008, the United States alone has boosted its output by upwards of 4 million barrels a day—more than Iraq pumps. If Latin American countries want to join that party, they may have little choice but to exorcise their nationalism demons.

A version of this article originally appeared in the September/October 2015 issue of Foreign Policy under the title “Crude Capitalism.”

Illustration by Matthew Hollister

Dr. Ana AlvesAssistant Professor of Political Science
Lee University