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Global Risk Insights

Global Risk Insights

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The Future of Oil Exporters in Latin America

The politics of oil in the two largest Latin American oil exporters—Venezuela and Mexico—have recently diverged. While Petróleos de Venezuela, S.A. (PDVSA) is now politically closer to the state than ever before, the Mexican Senate passed a landmark constitutional amendment allowing for private investors to partner with Petróleos Mexicanos (Pemex), the national oil and gas company.

Although both PDVSA and Pemex have taken opposite approaches to corporate governance, they are both reacting to the same problem: lower productivity levels and gradually decreasing revenues.

Where is the unique relationship between oil and the state in Latin America headed in this period of low productivity and decreasing oil prices? As was shown by socialist Hugo Chavez in 2003 and market liberal Enrique Peña Nieto in 2013, governments define how their oil mammoths operate in the global market.

Chavista PDVSA is less productive, more political

PDVSA has two connected problems: (1) lagging production against a backdrop of decreasing world prices for oil (expected to dip to $90 per barrel due to excess supply) and (2) politicization. If these issues are not resolved, it is difficult to see how Venezuela will overcome its macroeconomic woes, considering it is a one-dimensional economy based on oil extraction and exportation.

Since the PDVSA strike in 2002-2003, production has steadily decreased from 3 million barrels a day to 2.4 million barrels a day. Professor George Philip, a Venezuela and Mexico expert at the London School of Economics, notes, “Decreasing production is the main problem facing PDVSA.”

Related Article: Bitter Irony in Venezuela's Oil Sector

Despite lower production levels, do not expect for PDVSA to liberalize or reform under a Chavista governing party. According to Philip, a more viable option would be to restructure to the company as a fully nationalized entity and “change the whole employment structure.” Reforming the PDVSA labour force and bringing in qualified employees is a daunting task, as it “takes years to completely restructure a state company,” comments Philip.

The production problem with PDVSA is directly tied to a lack of human capital. Until human capital is developed, PDVSA will have to rely on short-term financing via external partners to even keep up with the current production levels.

The implications of the Chavez overhaul of PDVSA’s labour structure have been pervasive. Chavez turned PDVSA into a massive political entity strongly aligned with Bolivarian ideology. PDVSA workers and management alike are against liberalizing the oil company and opening up fully to foreign investment. Professor Philip states that there would be a political legitimacy problem in Venezuela if it were liberalized because Venezuelans and Latin Americans in general “do not like their oil controlled by foreigners.”

However, stalling oil production has been so remarkably detrimental to the state budget that in 2013 PDVSA began seeking external partners for joint ventures—the company has secured $10 billion since last year. These external partnerships could be seen as an emergency measure or at least a suboptimal decision for Chavistas. If anything, these partnerships demonstrate the deteriorated production capacity of PDVSA in the post-2003 period.

Mexico is eager for investment

Like PDVSA, Pemex is struggling with decreasing production. By August 2013, Pemex production levels had reached the lowest point in 18 years. In 2013, Pemex consistently failed to meet monthly expectations of oil production, thus prompting the governing party to call for the oil reform that was passed in December 2013.

Unlike Venezuela, there seems to be more optimism about the future of oil in Mexico. According to Emilio Lozoya Austin, the young CEO of Pemex, multinationals oil giants such as Chevron and Exxon will bring appropriate technology and human capital to Mexico.

These multinationals will use Pemex knowledge of the Mexican landscape to create a strategic partnership, which will strengthen the company while expanding private industry in a country that is trying to stay competitive in international markets.

Of course, this is the message that Pemex executives and the central government have told the press since August 2013. In reality, there needs to be oil for the government message to become a reality. If there is no easily extractable oil, there will not be as much foreign investment as expected, and the status quo of low production levels will remain.

Related Article: Chevron Seeks $32.3M in Legal Fees over Ecuador

For now, Pemex is still at the negotiation table with other oil companies, which Lozoya calls having “discussions with players” (meaning foreign players), to explore harder-to-reach oil reserves. Until a deal with a foreign company is signed, Pemex will have to continue picking the low-hanging fruits.

Two different paths to oil production

Pemex and PDVSA are examples of the two alternative trajectories for oil in Latin America. At this point, the main objective for both companies is to increase production and improve human capital. For now, Pemex has chosen liberalization as its route.

PDVSA is still firmly within the political status quo of the Chavez decade and as long as Chavistas stay in power, it is doubtful that there will be oil reform. The demonstrations in Venezuelan cities are unlikely to impede oil production further, as oil and gas companies are accustomed to working in unfavourable political environments. Since PDVSA is pro-government, it is doubtful that its employees will side with protesters and take collective action measures to impede production any further.

Regardless of Mexico’s liberalization of oil and Venezuela’s need for a more competitive national oil company, the conditions in these countries are not expected to change much in coming years. Pemex will try to aggressively attract much needed foreign investment on the service and operational sides.

Still, no foreign company can legally take projects from Pemex and, no matter what, Pemex would be allowed to keep all of its current production assets. Under a “round zero allocation,” Pemex will remain the strongest oil player in Mexico.

PDVSA, however, will probably keep its governance structure and deep rooted political alignment. At this point, PDVSA might as well be the best-oiled part of the United Socialist Party machine.

A special thanks to Dr. Professor George Philip of the London School of Economics Department of Government, who provided valuable insight on the relationship between oil and the state in Venezuela and Mexico.

By Daniel Lemaitre




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