Mexican Election Brings Energy, Trade Into Focus

President-elect eyes expansion of refining capacity and gas production.

Andrés Manuel López Obrador decisively won the Mexican presidential election on July 1 in a populist campaign that had energy reform as one of its core issues.

It was only a few years ago that the country’s vast oil and gas sector was opened up to international markets and investors. While the process has been slow in some respects, it was seen as a significant positive, in that it would attract global interest and fresh capital as the government loosened its grip.

Since the nationalization of hydrocarbon resources in 1938, Mexico’s energy industry and public-sector finances have been “closely interlinked,” Gustavo Stenzel and Santiago Petri of Franklin Templeton Emerging Markets Equity said in a recent note.

They pointed out that Pemex, the national oil company, transferred royalties and taxes to the federal government that by 2014 represented up to a third of fiscal revenues. Thus, “the government’s burden on the national oil company resulted in declining production.”

Cash Constraint

Having to pay 50% to 60% of its revenues in royalties and duties compromised Pemex’s cash generation, which resulted in increasing leverage to finance its required capital expenditures plan.

This led to a much-needed “rescue” of the sector, industry analysts explain. In order to ease the government’s and energy industry’s financial constraints, comprehensive energy reform was approved at the end of 2013, opening it up to private investors and allowing access to the country’s energy sector.

The reform allowed for new contracting agreements, including profit sharing, production sharing and licenses that provided more alternatives to previously restrictive, service-only contracts. The policies also were designed to enable more independence for Pemex to make strategic investments and plan capital expenditures.

The victory of López Obrador, a former Mexico City mayor who is popularly known as AMLO and takes office December 1, brings plans to revise, and possibly even delay, new offerings for oil and gas exploration acreage, while expanding refining capacity and developing domestic gas supplies.

Trade Pacts

Some of these proposals could be justified by the United States’ at times heated rhetoric on global trade matters including – directly affecting Mexico – the North American Free Trade Agreement (NAFTA), which could also negatively impact the reliability of U.S. energy supplies.

Mexico currently has more free trade agreements in place than any other nation, including the Trans-Pacific Partnership, from which U.S. President Donald Trump has sought to withdraw.

However, analysts say that AMLO should realize that his attempts to re-channel resources back to the national oil company would likely weaken his attempts to reform income distribution,

In a post-election speech, AMLO gave some comfort to markets, expressing a willingness to finalize NAFTA (he is leaving Mexico’s negotiating team in place), and the risk concerns have eased a bit with him speaking of more competitive wages and encouraging investment in Mexico.

Investor Interest

“Investor worries have been somewhat mitigated,” one analyst explains. Mexico will continue to attract international investors now, and more so with López Obrador’s statements about infrastructure renewal and investment.

The energy reform initiatives of 2013 had resulted in nearly $200 billion in new foreign investment to boost production. In just the downstream area, 30 new private operators are aiming to open more than 1,700 gas stations, enabling the development of a competitive retail market.

Energy-sector reforms have also been embedded in the Mexican constitution and supported by implementation laws passed by the Congress.

“In our view, AMLO should realize energy reform is an asset to the country and key to unleashing productive forces that will enable Mexico to restore production levels,” the Franklin Templeton analysts said.

Photo Credit: Edgard Garrido/Reuters