Politics and Oil: Mexico’s Road to Reform

Is Mexico finally on the verge of a historic reform push? Expectations are on the rise, and for good reason. In office just over six months, President Enrique Peña Nieto has taken steps that suggest he is serious about pushing through policy changes meant to, among other things, improve the quality of an education system that produces students who score lower than their counterparts in all other OECD countries in reading, math, and science, and to open the country’s lucrative telecommunications sector, which could lower prices for millions of Mexican consumers. The government is also pushing for a state and local fiscal responsibility law intended to prevent governors and local authorities from taking on too much debt. Peña Nieto’s financial reform could also help promote public access to credit. According to data from the World Bank, credit as a percentage of GDP remains at about 26 percent (in 2011), much lower than in Latin American peers like Brazil (61 percent) and Chile (71 percent).

But the highest hurdle, energy reform, has not yet been cleared.

In the past decade, Mexico’s energy sector has suffered from deteriorating operational, financial, and technological capabilities, sharply lowering production for a vital source of state revenue. Production has fallen from a record 3.4 million barrels per day in 2004 to about 2.5 million today. Faced with rising pensions and health-care bills, the government’s high dependency on oil revenues (around 30 percent of total revenues) is becoming increasingly worrisome.

Given the opportunities it might create and its impact on the broader economy, substantive reform of Mexico’s energy sector has also captured the attention of foreign investors. In particular, Mexico may have the world’s fourth-largest shale deposits, exciting intense investor interest in opportunities for private participation in both offshore and shale plays through profit-sharing agreements (possibly a variant of production-sharing agreements).

Energy reform would also offer Peña Nieto an important political victory, since he will have succeeded where so many of his predecessors have failed. Past attempts have been defeated by a populist commitment to nationalized energy that is written into the Mexican Constitution, limits on investments by state-owned oil company Pemex, the ability of state governments to grab a large share of the industry’s resources, Pemex’s labyrinthine bureaucracy, assertive labor unions, and politicians who were unwilling to accept the costs and risks that come with change.

The Mexican public has historically opposed the constitutional changes needed for real reform, and it’s not clear that this has changed. Recent polling data suggest that 65 percent of Mexicans are aware of the so-called Pact for Mexico, the president’s broader reform plan, but there is no public survey on popular attitudes toward the opening of the energy sector to private investment. Yet, this time around, Mexico’s president has the demonstrated political will to bring about change, and there are enough lawmakers within his own party and the major opposition party, the National Action Party (PAN), to negotiate a substantive agreement by the end of 2013.

That said, there are a few obstacles Peña Nieto must overcome. The most underappreciated of these is the need to reform Mexico’s electoral politics. In early May, the Pact for Mexico survived a challenge from opposition parties when Peña Nieto agreed to allow discussion of electoral reform before September, forcing lawmakers to debate a hotly contested issue just before they take up a crucial energy reform plan that demands goodwill and compromise.

The Mexican Congress is currently in recess, but legislators have announced that they will hold at least two extraordinary sessions in July and August to debate some bills left on the table, helping to clear the legislative calendar. But electoral reform was not included in the schedule; lawmakers are still in the process of designing it and are probably waiting until after local elections on July 7 to finish drafting their proposal.

The fight over electoral reform will sharpen the battle lines among the three major parties just as energy reform will require open negotiation among political rivals. Some opposition factions want a reform that not only increases transparency in the use of campaign funds, but that also includes major changes to the electoral and political systems. Senators from opposition parties — the PAN and the Democratic Revolutionary Party (PRD) — want to introduce a second round in presidential elections and reelection of legislators and mayors, as well as introduce coalition government and chief of cabinet, probably as a way of extracting concessions in exchange for support. A large segment of the ruling Institutional Revolutionary Party (PRI) has long opposed these proposals for fear that a second round would enable the PAN and PRD to organize resistance to a PRI candidate and that an end to term limits for lawmakers and mayors would make it more difficult for the party to enforce discipline among its members. In addition, a system that provides more power for parliament could heighten the risk of gridlock at a crucial moment for reform. As a result, the government is unlikely to accept all these demands.

In the end, if the government is as serious as it appears on energy reform, it will have to compromise on electoral reform. Peña Nieto remains committed to keeping things on track, and he will probably cede some ground on the electoral front.

That’s why odds of success on energy reform remain good, but the next few months will test the new president’s political skills.

Maria Jose Hernandez is an analyst in Eurasia Group’s Latin America practice.