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Rajan Vig

Rajan Vig

Rajan is a trader in Mexico City and works across the fuels, gas and electricity space. He is currently a Board Member of ACE (Asociación…

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A New Era For Mexican Energy

At the end of this month, on November 30, the sun will set for the very last time over a PRI and PAN presidential reign that has lasted for more than 80 years in Mexico. As of December 1, the MORENA party will be inaugurated and Andres Manuel López Obrador (AMLO) will take office to lead the country for the next 6 years.

But what will this mean for Mexican politics and energy? The general attitude towards the next administration is one of skepticism by those in the corporate world, above all in the energy sector. MORENA as a political party and ideal is unproven in Mexico and its heyday comes at a time when international politics is going through its own transformative period.

Credit Agency Fears

AMLO has not yet taken his presidential oath and already credit agencies have reacted negatively to how 2019 might pan out. On October 19, Fitch Ratings downgraded Pemex to BBB+ and revised its outlook on debt held by the state oil company to “negative” from “stable”, based upon Pemex’s $77 billion of notes. The retort from the future head of the Energy Secretariat (SENER), Rocio Nahle, was forceful, calling the decision “absurd”. She suggested that Pemex needs to spend in order to recover and, on that front, she may have a point. Having said that, markets respond based upon predictions and the international purveyor is arguably less bullish about the development of energy markets coming into a new administration. Standard and Poor’s and Moody’s have also downgraded Pemex from “stable” to “negative”, citing policy uncertainty as the catalyst behind their decisions.

Challenging the Constitution

There is a strong argument for credit agencies jumping on the bandwagon and riding the new administration down in an unfair fashion before it has even taken office. Nonetheless, the new party is not doing itself any favors. On October 18, the "Parliamentary Gazette of the Chamber of Deputies" (Gaceta Parlamentaria) published a suggestion for change in reforms, amendments and repeals to the Constitution. In this particular document, MORENA suggested that the National Commission of Hydrocarbons (CNH) and Regulatory Commission of Energy (CRE) sit under the Energy Secretariat (SENER) and function as one. MORENA suggested that both groups should lose their "legal autonomy" which is a complex point since SENER already has policy control over CNH and CRE as it establishes “Law”. The implementation and regulation of that Law is then conducted by the CNH for upstream oil and CRE in general across power, gas and fuels.

The thought process behind this decision was that taking the legal autonomy away from CNH and CRE would make business less bureaucratic for outside investors, having to only go to SENER for any issues. Given that the “Law” indicates legal autonomy for CNH and CRE as defined in the Constitution, the question remained on how AMLO had planned to implement this change.

Upon the very serious threat of Mexico’s country profile being downgraded further by credit agencies, the concept was rejected by the House of Representatives (Cámara de Diputados) and MORENA swiftly mentioned it will no longer be pursuing this agenda. The credit agencies remain tentative.

MORENA Update

In my last article, I talked about three of the main arguments MORENA had presented publicly and I would like to follow up on where we are with those issues and integrate them with more recent dialogue from the MORENA administration.

The party had started their presidential campaign discussing how they were going to build six refineries; this then dropped to two refineries and now they have settled on one mid-sized refinery costing approximately $8.4 billion with an additional $2.6 billion to revive the current refineries.

But how feasible is this? Pemex is currently the most indebted national oil company in the world with far bigger hurdles on the exploration and production side than in the refining of crude oil. It raises a question I have previously asked: who is willing to co-invest with such a high-risk investment alongside a deeply inefficient company such as Pemex? MORENA has made it clear that Mexico should be producing more of its own oil, so logic would suggest the principle focus should be on getting crude out of the soil on home territory. Related: Oil Prices Fall To One-Year Lows

Alas, there are some grave inconsistencies in MORENA’s dialogue. The party wants to focus on being self-sufficient and believes is planning to spend $8 billion dollars of taxpayer’s money on building a refinery without even having the four native crude oils available at their disposal. This has raised major concerns for investors in Mexico and the development of an open market.

Refined Products in Mexico

AMLO continues to proclaim that, within three years of his presidency, the party hopes Mexico will be in a position to stop buying foreign fuel. This remains a nonsensical and poorly informed idea - Mexico continues to be the 6th largest consumer of gasoline and diesel globally. In order to justify a halt in refined fuels imports, not only would the country require consistent domestic production but a profound, intermodal infrastructure. Mexico is deeply underdeveloped from an asset stance. There are many exciting marine and transloading terminals being proposed, but only a few are currently in operation and even fewer are at capacity. On the coast, terminals are being developed, mostly on the Mexican Gulf Coast and fundamentally in Altamira and Veracruz. These are long-term projects though and do not address the issue of how to get oil from the receiving terminals to the end user. There needs to be deeper investment in: transloading terminals inland, truck racks, improved roads, storage tanks, and efficiencies in last mile trucking deliveries. Pipeline projects are at a halt due to security and local political issues, and security risk remains a serious issue for investors. Therefore, AMLO’s desires have little commercial support or logic.

As well as his stance on imports, AMLO has proclaimed that he will also stop exporting crude oil. His promises to revamp the six existing refineries and build a new one are based on his plan to stop exports of oil in the medium term, starting in the middle of his presidency. AMLO’s rationale behind this is that he would need to process his own material domestically for domestic consumption. There are three questions here: pride and nationalism aside, how sensible is it to build a new refinery and invest in the existing refineries; how sensible would it be for Mexico to stop importing refined products; and should Mexico stop exporting crude oil?

Refineries in Mexico

• Refineries are incredibly costly and provide little ROI and profit margin. Petrobras, the national company of Brazil, encountered a very similar dilemma to Mexico with regards to including consumption of refined products. However, they delayed the construction of two refineries due to the sheer cost of the investment. In July of this year, CNPC (China National Petroleum Corp) agreed to potentially help Petrobras complete a refinery it had started constructing in 2004, a project that has cost Brazil $14 billion so far. It would be sensible for MORENA to take heed of the mistakes of other Latin American nations.

• Refineries in Mexico are currently configured to produce more fuel oil than diesel, making them less efficient in producing the light ends and distillates the country craves. Yes, of course there will be a benefit to returning the existing refineries to 100% capacity but that does not deal with the issue that they’ll be producing less of what the country needs.

• Mexican heavy crude isn’t easily converted into gasoline, which is one of the reasons why a large majority of its flagship heavy crudes, Maya and Altamira, are exported. The other medium and light crudes, Istmo and Olmeca, are generally used for domestic refining.

• Mexico is in the highly advantageous position of being on the doorstep of the world’s most efficient refining hub, the US Gulf Coast, which produces over 45% of total U.S. petroleum refining capacity at a highly favorable cost.

Stopping Fuel Imports

• AMLO is at risk of creating a domestic gasolinazo (spike in gasoline prices) whereby costs of producing the amount of gasoline the country needs may increase the cost of the product: the lack of efficiency in domestic refineries will cause prices to rise. A common move by politicians to this type of disaster would be to subsidize oil prices. And let’s be clear, many countries around the world subsidize their fossil fuels. But, unlike other oil-rich nations such as Saudi Arabia, Mexican politicians have rarely used the subsidies to provide huge discounts to consumers but instead controlled and stabilized prices by responding to market conditions. That is the reason why gasoline prices have remained higher than in the United States for the past couple of decades but have fluctuated less. Now, with an open market, a continuous gasoline production decline and the introduction of an excise tax (IEPS), the cost differential between the U.S. and Mexico has been accentuated. The general public think rising prices is a fault of the energy reform but in reality, it is a cause of production decreases, a devalued peso and an increase in taxes to fill a void created by Pemex’s profound losses.

• In the world of fuels trading, arbitrages play a key role. In short, it makes sense for countries to import a product rather than export or produce due to international imbalances and cost fluctuations. By restricting Mexico from importing fuel and using all its own crude to create refined products, the country is effectively losing out on market dynamics and benefits.

• Many countries justify imports of refined products due to a lack of infrastructure domestically, including the USA, where states such as Florida and Oregon may access foreign product due to the expensive nature of transport domestically. Mexican states such as Michoacán, Oaxaca and Chiapas encounter similar problems. Utilizing nearby ports such as Lazáro Cardenas and Salina Cruz may be more economical to receive international product than battling through domestic landscapes and inefficiencies from refineries to end consumers.

• Frankly speaking, refined product production for gasolines and diesel is exceedingly lower than domestic production and the MORENA party needs to be realistic about how quickly it can turn around the failing capacity of existing refineries. To put this argument into perspective, in July of this year, Mexico produced a shocking 0.2% of its national consumption for its higher grade of gasoline, Gasolina Premium.

Stopping Crude Exports

Last year, Mexico was the 14th largest crude exporter in the world, totaling $19.9 billion in value or 2.4 percent of the total crude oil exports globally. Is Pemex, the world’s most indebted oil major, really in a position where it can afford to discount close to $20 billion, making up approximately 25 percent of its outstanding bond value (debt)? In simple terms, it seems not and if AMLO does decide to go down this path, he must have a proven budget in place to elaborate on how he can afford to make such a decision.

Seismic shifts

In other oil related issues, AMLO declared in front of businessmen recently in San Luis Potosí that he will not support the use of fracking to extract oil or gas during his tenure. The extraction of unconventional resources is legitimately contentious - the impact that it has on the environment through use of water (a precious commodity in Mexico as well as many other developing nations) and its possible seismic effects do raise some doubts about the efficiency of the technology. Pemex signed a deal in March of this year with a U.S. based entity to explore the Eagle Ford field in Mexico using fracking technology. AMLO has made his stance very clear on this contract: it will not happen under his presidency. Related: The Biggest Threat To Dollar Dominance

But Mexico cannot have its cake and eat it. In neighboring Texas, USA, shale gas is booming which has buoyed investment in derivative products such as LNG export terminals and petrochemical plant investment. The causal effect in the following years will be higher LNG exports and, in turn, will raise gas prices domestically, which will have a grave effect on Mexico. The country currently imports more natural gas from USA than it ever has; in fact, exports to Mexico have more than tripled to close to five billion cubic feet per day in the past decade. It is clear that shale discovery offers an alternative and viable option to Mexico, both in crude oil and natural gas, in retaining domestic consumption and not heavily depending on U.S. prices. It is a telling message from AMLO that he won’t be bullied around with existing contracts but it will have to be seen if this decision will come back to haunt him in the years ahead.

Fighting Corruption

On November 1, thirty days before taking office, AMLO presented his Presupuesto (Budget Estimate) for 2019. Donning a crisp white Guayabera, he faced the camera from behind a table surrounded by budgets and presentations. He spent approximately 27 minutes elaborating on how he wishes to steer the nation fiscally. On the topic of energy, he made himself clear: there will be no increase in taxes and no new ones will be created. He assured the people of Mexico there will be no gasolinazos and prices will only increase due to market inflation. He then rhetorically asked himself how he will find the budget to do that. His answer: eliminate corruption. According to Transparency International in 2017, Mexico is ranked 135th in a list of 180 countries, listed from least to most corrupt. It is neighbored by failed states and loose democracies such as Venezuela, Haiti and the Republic of Congo. In other words, the current state of Mexican corruption is on par with some of the most ruptured and dictator-driven nations in the world.

In 2015, the United Nations released a document called “United Nations Millennium Development Goals” and within it, it explained the detrimental effects corruption has on economic and social development. It stated that there are three key ways to end corruption: focus on education; create a culture of integrity and demand accountability. These are expansive and generational issues that require a huge overhaul of social and political values. AMLO has lofty ideas about tackling these issues within the first year of his presidency. To take a step back, during most of its post-revolutionary history - that is to say the creation of the National Revolutionary Party (PNR), (later becoming the Institutional Revolutionary Party (PRI) that monopolized effectively all levels of government for 71 years - Mexican politics was marked by having an authoritarian political system. This was arguably necessary immediately after the Mexican Revolution as a form of piecing together a fractured state. However, the PRI remained at the helm of the political hierarchy for seven decades. As a result, Mexican politics and society evolved into an arena steeped in hegemony, totalitarianism and caciquismo (local tribal male ruling) that brewed a sense of machismo (male bravado) and paved the way for corruption. These are idiosyncrasies that will not dissipate overnight. The nation has come a long way, firstly with the PAN and now a true consolidation of democracy with the election of the MORENA party. Its future president has highly ambitious plans to defeat corruption and clearly has the support of the people to enact those plans. Should he fail, his budgetary plans to not raise taxes may require an overhaul.

There is a famous Mexican saying, “él que no tranza no avanza” meaning “he who does not compromise, does not advance”, alluding to being swayed by bribes. This entrenched idea of corruption in society is what AMLO faces; a societal wall he must break. Whilst one President looks to build a wall, his colleague south of the border will look to break one.

By Rajan Vig for Oilprice.com

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