Why a historic energy reform will be felt from Brazil to China.
In Mexico, all eyes are on a historic reform of the energy sector — reform which opens up the country’s oil to real foreign investment for the first time in more than 70 years. But the real impacts of the changes in Mexico could be felt further abroad — from Venezuela to Brazil and even in Canada and the United States and China.
By finally prying open a resource-rich country to foreign investment, Mexico promises to up the ante for other regional governments who have to compete for scarce capital to develop their own energy projects. But unlocking a potentially important source of supply could also soften historically-high oil prices by the end of the decade.
Analysts already expect that rising output from the United States, combined with increased oil production from Iraq and Iran, could push prices down sooner rather than later. Mexico could speed up that downward slide just by giving the market the expectation of an influx of new investment. And price matters for development, because some tight oil projects in the United States and oil sands development in Canada rely on high oil prices to be viable. In other words, if crude oil slips much below the $100 range it has traded at for a couple of years, some projects in Canada and the United States won’t make economic sense.
Another country that will likely be keeping an eye on the Mexican reform is China, which has already invested tens of billions of dollars in Latin American energy resources, but which is especially eager to start tapping expertise in two areas in particular: hydraulic fracturing and deep-water oil production. (That was the rationale for China National Offshore Oil Corporation’s acquisition of Nexen, a Canadian energy company active in both areas.)
Mexico would certainly be eager to tap rising demand for oil in the Asia-Pacific, including China. That’s because of the fundamental shift that’s taking place in North American energy production as a whole: With U.S. output booming, Canada and Mexico are both looking for new export markets to replace demand from their traditional customer, the United States. An additional reason for Mexico to look abroad to sell either crude or refined products: The probable construction of the controversial Keystone XL pipeline from Canada down to the U.S. Gulf Coast. The pipeline would give U.S. refineries a way to source the same sort of heavy oil they’ve traditionally bought from Mexico, but at a cheaper price (for now).
The Mexican reform is attracting so much attention because it went further than many analysts (and oil executives) dared to hope when President Enrique Peña Nieto made it a centerpiece of his campaign. Given how sacrosanct nationalized oil is — it’s a tenet of the Mexican Constitution and a central component of the mythology of the revolution — most observers expected modest, piecemeal changes. They expected that Peña Nieto might secure the necessary support of political parties other than his own by taking a cautious approach to reform rather than a wholesale change in the operating climate for international oil companies.
Wrong. While the Mexican state will still "own" the oil under its land and off its coasts, the reform will enable foreign firms to sign production-sharing agreements that will give them a stake in the development of resources, rather than just a contractor-type relationship.
Granted, the devil’s in the details. Certain aspects of the reform are confusing and still controversial, and there won’t likely be any new contracts until late next year at the earliest. But the Mexican government expects the reform to boost oil production from about 2.5 million barrels a day today to 3.5 million barrels a day by 2025. Likewise, the reform should allow Mexico to eventually tap abundant resources of shale gas (it shares mighty cross-border gas fields with the United States) and nearly double gas production to 10.4 billion cubic feet a day by 2025.
The reform was a political slog to the end, with one opposition congressman stripping down to his underwear to protest what opponents see as a sell-out of the revolution. But given Mexico’s steadily declining oil production, and having completely missed the shale-gas revolution that has transformed the U.S. energy picture, it was a necessary step.
The shockwaves will likely be felt further away than just Mexico, though. Other countries in the region are also under pressure to revive ailing oil industries (Venezuela), tap massive-but-hard-to-reach oil reserves (Brazil), or take advantage of some of the world’s most promising shale reserves (Argentina).
Take Venezuela. The country is blessed, on paper, with the world’s biggest oil reserves. Yet oil production has dropped almost one-third since 1997, and now sits at just 2.3 million barrels per day. Petróleos de Venezuela, or PdVSA, desperately needs capital and foreign technology to tap the hugely promising Orinoco belt.
And yet that’s precisely not what’s forthcoming due to the Venezuelan government’s heavy-handed approach to energy investment and contracts. While Chinese companies have poured billions of dollars into the company in exchange for access to Venezuelan oil, PdVSA needs more.
Nicolás Maduro, the successor to strongman Hugo Chávez, seems to recognize that. In private, he has reportedly promised more reasonable terms to foreign oil companies. Yet they are skeptical of pouring more money into Venezuela until those promises are codified in law, something that is at least as tricky in Chavista Venezuela as in post-revolutionary Mexico.
"Once Mexico gets this in place, people will use it to prod Venezuela to change, even though that is politically unpalatable," Pedro Burelli, a former PdVSA board member and critic of Venezuela’s management of its oil resources, told Foreign Policy.
"These two, Mexico and Venezuela, have essentially been dormant during the oil boom. And that is going to change now," he said.
If Venezuela does soften the way it deals with foreign companies — by actually honoring contracts it signs with foreign firms, for example, or offering majority stakes in lucrative fields — it could in time return Venezuela’s oil production to where it was. That, in turn, would help fill Caracas’ ailing coffers, even if it means abandoning part of Hugo Chavez’s revolutionary legacy.
"Energy nationalism has a limit. And that limit is when it starts doing damage to your nation," Burelli said.
Brazilian energy officials will also be keeping an eye on how Mexico’s reform plays out. Since it announced potentially huge offshore oil finds almost a decade ago, it has been touted as the producer-to-watch in Latin America. But that was in no small part because Mexico and Venezuela were either off-limits or unappealing to foreign investors.
Make no mistake: Brazil needs to make sure it offers attractive terms to bring the investment it needs to tackle the hugely expensive and complicated development of oil buried thousands of feet under the seabed offshore. Under current plans, state oil company Petrobras has to be the sole operator of all offshore projects, and international firms would have to source many of their supplies inside Brazil.
Indeed, at a much-hyped auction a> of offshore blocks recently, Brazil was embarrassed by a frostier-than-expected reaction from international oil companies. Only one bid emerged, at the minimum price.
"Brazil will be more responsive. They should look at what Mexico is doing and say, we sort of lost the plot and got sidetracked" in terms of how to attract foreign investment for energy development, said Duncan Wood, director of the Mexico Institute at the Wilson Center. "So this is another reason Brazil could turn back to more liberal policies."
The repercussions of Mexican reform could reach the other end of Latin America, where Argentina’s government is working hard to make the country attractive for foreign investment again after an ugly spat with Spanish firm Repsol over the expropriation of Repsol’s Argentine assets.
Buenos Aires and Repsol appear ready to compromise on that fight, itself a significant concession for the government of Cristina Fernández de Kirchner. And Chevron has already pounced on Argentina’s potentially huge shale reserves despite its own run-ins with Argentina’s government in the past.
Of course, the big question in Argentina, as in Venezuela, is whether domestic politics will trump economic wisdom, even for something so vital as developing abundant energy resources.
Ironically, it was Mexico’s nationalization of oil in 1938 that kick-started oil investment in other countries around the region, notably Venezuela. With Peña Nieto’s ambitious reform, history may be about to repeat itself.