Mexico Tries to Turn Back the Clock on Energy

Mexico’s leftist president, Andrés Manuel López Obrador, is all but gutting the country’s historic energy reform—with potentially disastrous consequences for his own ambitious policies and Mexico’s future.

This week has seen a double whammy to the once-promising energy reform, passed by his predecessor, which reversed decades of resource nationalism in a bid to tap private capital to rejuvenate Mexico’s plunging oil production. One international firm that won the rights to drill for oil in the waters off the coast of Mexico gave up after spending millions of dollars and finding nothing. And where there is oil, Mexico’s state-owned behemoth is reportedly angling to elbow in on the action and push aside the private firm that found it.

The upshot: Even without formally rescinding the energy reform, López Obrador is eviscerating it. Instead of burying the idea that Petroleos Mexicanos, or Pemex, Mexico’s inefficient state-owned oil company, can turn the country’s fortunes around, López Obrador is trying to turn back the clock.

“There has been a profound political change in energy policy,” said Jose Valera, a partner at Mayer Brown LLP, a law firm closely watching the Mexican energy sector. The previous government of Enrique Peña Nieto opened the energy sector to foreign investors for the first time in almost 80 years. The central thrust of that reform was to stop trying to rely on Pemex to pump all the country’s oil and to tap international capital and technology instead.

In less than a year under López Obrador that has all changed. As in decades past, the government is hoping to use Pemex as a tool of economic development, tasking it with developing oil fields it lacks the capability to operate efficiently and ordering it to spend billions of dollars on new oil refineries which the country arguably doesn’t need.

“In Mexico, development was always oil-driven. It was a historic error. The fact that oil brings in income doesn’t mean it creates optimal development—and this government is falling into the same trap,” Valera said.

López Obrador has always been opposed to the 2013 energy reform and based one of his earlier runs for president almost entirely on opposition to it. The reform was controversial in Mexico because it reversed what many saw as an important legacy of the early 20th-century Mexican revolution: nationalization of the county’s oil wealth in 1938.

After he handily won the presidential election last year, López Obrador moderated his tone, vowing not to overturn the reform altogether but to pause the energy sector’s opening while his government studied the terms of the contracts signed with scores of international companies. Now that pause looks to have turned into a full stop.

“There is less chance now than a year ago that we will see new contracts under AMLO,” said Duncan Wood, the director of the Mexico Institute at the Wilson Center in Washington, referring to López Obrador by his commonly used nickname. “The government seems to have hardened its position, essentially telling investors they should be happy they got the contracts they got, and happy they’re not being taken away.”

Unless they are. This week, Reuters reported that Pemex is angling to gain operational control of the first big oil field discovered after the sector’s opening, discovered by the U.S. firm Talos Energy. On Thursday, López Obrador denied that the government is trying to take control, but U.S. government officials are reportedly concerned. Also this week, a different consortium including Talos gave up trying to squeeze oil out of what seemed one of the more promising areas initially offered up for exploration in 2014; the consortium surrendered its rights back to the government, underscoring how many international firms are souring on Mexico’s potential under López Obrador.

Almost the opposite is taking place in Brazil, another country that has a financially and operationally strapped state-owned oil company but that has courted international firms to explore its own massive offshore oil resources. Just last week, Brazil said that more than a dozen international oil companies will bid for drilling rights in its next offshore auction—bringing in at least $25 billion for the government. Meanwhile, thanks in part to its opening to international firms, Brazil is setting new records in oil production.

But for Mexico, the problem remains: Oil production has plunged, which means less revenue for the federal government. The reform, by attracting private capital, was meant to reverse that decline and eventually bring billions of dollars in revenue to the Mexican state. With the energy opening essentially moribund, where does that leave Mexico’s oil sector? If López Obrador has his way, it’s back in the hands of Pemex, which for him is a way to scratch his nationalist itch—the same way he insists on building expensive new refineries rather than continue importing gasoline from the United States.

What López Obrador wants is not so much to increase Mexico’s oil production as Pemex’s—even if that ends up costing more to deliver less. For instance, the government’s plan now is to give Pemex a bigger role in operating shallow-water, offshore oil fields, even though that will mean hiring specialized companies to do work the state firm can’t.

“Every extra barrel is going to cost the taxpayer a lot more than if you tendered a private contract” for oil exploration and drilling, Wood said. Just to keep debt-ridden Pemex afloat, the government is already pumping cash into its coffers, including $5 billion last month.

“This could be another money pit where AMLO tosses billions of dollars down a dark hole to get a few thousand extra barrels” of oil, Wood said. “This administration is not interested in economics, it’s interested in politics—and this is an example.”