Mexico’s presidential elections trigger oil policy debate

Nov. 14, 2005
The sexennial presidential season in Mexico (fall 2005-spring 2006) promises to be more than flag-waving in oil policy, as was the case in the elections of 2000.

The sexennial presidential season in Mexico (fall 2005-spring 2006) promises to be more than flag-waving in oil policy, as was the case in the elections of 2000. At that time, then-presidential candidate Vicente Fox reversed his earlier advocacy for the privatization of national oil company Petroleos Mexicanos (Pemex), and his campaign featured the sound bite, “Pemex will not be privatized.”

Candidates this year, however, are addressing substantive and specific issues in energy policy.

On Sept. 12, Fox, who is entering the sixth and last year of his term, announced 10 policy measures for the energy sector, including one constitutional change. While most of the measures were meant to fine-tune existing policies, three of them broke new ground.

The proposal for a constitutional change was nothing less than a move that put the chess queen of Mexican politics-oil policy-in check. Mexico’s political system had no choice but to react.

In September, the all-but-certain presidential candidate of the left-of-center Democratic Revolution Party (PRD), Andrés Manuel López Obrador (AMLO), who until recently was mayor of Mexico City, uploaded to his website a set of 50 white papers on diverse topics of public policy, one of which was the energy sector (www.amlo.org.mx).

On Sept. 20 Adrián Lajous, a former Pemex executive with longstanding ties to the opposing Institutional Revolutionary Party, circulated a paper highly critical of the technical analysis and policy proposals of the presumptive PRD candidate and his team of advisors.

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And on Oct. 27, speaking to the annual meeting of the National Chemical Association, Ernesto Cordero, a campaign spokesman for the National Action Party’s presumptive candidate, Felipe Calderón, outlined ideas for the energy sector in a presentation that is posted on its web site (www.felipe-calderon.org). Of his several proposals, the most innovative is one that visualizes private natural gas production for “self-use,” such as for manufacturing or electric power generation. He also proposes strategic alliances with international oil companies (IOCs). Calderón, in apparent approval, also cites Pemex’s reserves replacement program for 2006-10 (Fig. 1).

Effects on Pemex

Pemex continues to be blocked from developing upstream associations with IOCs, as the proposals of Fox and López Obrador remain silent on that subject.

Lajous, who currently is on the Schlumberger Ltd. board of directors, has always been opposed to such measures. In his paper, he comments that Pemex’s deepwater problem is not a deficiency in technology per se, but rather a lack of technical skills in its crews and of high-level operational experience in its managers.

Meanwhile, Pemex’s deepwater development is proceeding, along with several new test wells. One well being drilled by Diamond Offshore is expected to be complete in November, and Pemex has extensive 2D and 3D seismic data under review.

And while the company’s reserves replacement record continues to be weak in terms of new 1P (proved) discoveries, it is making progress in terms of 3P (proved, probable, and possible) discoveries. Pemex chief Luis Ramírez Corzo told Fox at a luncheon at the company’s upstream biennial technology conference in Veracruz in February that during 2001-04 Pemex had increased its reserves replacement ratio to 57% from 14%. However, Pemex’s 1P reserves replacement ratio for crude oil in 2004 was 14.9%.

It was on this occasion that Corzo told the president, “We should consider an opening of the [oil] sector that is intelligent, timely, and efficient, one that avoids the privatization of the nation’s petroleum resource.”

Reserves accounting

There have been two important changes in the way Pemex accounts for its oil and gas reserves: One of these was implemented in 1998, the other in 2003. In each case the goal was to bring Pemex’s reporting system into alignment with international practices. The lower proved reserves now represent only those reservoirs currently in production; these are the reserves termed “1P.” The inclusion of probable and possible reserves gives estimates for reserves that are termed 2P and 3P.

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Pemex’s reporting of the arithmetic of reserves adjustments is limited to figures for discoveries, revisions, and field delineations on a 3P basis, a departure from industry standards that call for 1P or 2P accounting (Table 1).

Pemex’s reserves/production ratio for crude oil is 10 years if only proved crude reserves are considered. The R/P ratio doubles if 2P reserves are taken into account and nearly triples (to 27 years) if all proved, probable, and possible reserves are figured in.

Fox’s proposals

Several of Fox’s proposals concern government pricing formulas for petroleum products and electricity, which directly or indirectly had been affected by the market spikes in the US as a result of Hurricane Katrina. Others concern gas supply and public safety.

For the government, the matter of natural gas pricing has been especially difficult, as federal pricing policy since the mid-1990s has been tied to a netback system that links Pemex’s prices to those of the spot market at the Houston Ship Channel.

In January 2001, when the “Enron” price of gas in the US reached $7/MMbtu, the Fox administration backed out of the Houston netback scheme, at least in practice (it is still on the books). The government offered Mexican industrial users gas for 3 years at $4/MMbtu-the so-called 4 x 3.

With this precedent, it was natural for the Fox administration to react to the “Katrina” price of gas (above $10) with an offer of $7.60 beginning in September.

One Fox proposal is to create a new oversight board for Pemex that would include energy experts from business, government, and academia; in parallel, Pemex supports a proposal for a new board of directors with qualified members.

Two proposals deal with private investment: One offers to open private investment in the area of petroleum products pipelines and storage facilities. The rationale here is that Pemex lacks an adequate investment budget in these areas, the result of which has been a string of dozens of pipeline accidents and oil spills, especially in the oil-producing states of Tabasco and Veracruz.

A partial cure for the inadequacy of Pemex’s investment budget is the long-discussed “fiscal reform” of Pemex. The goal was to reduce the “confiscatory” taxes on Pemex, as Lajous terms them, toward the end of leaving more money from export revenue and domestic sales for Pemex’s own investments in infrastructure and maintenance.

Congress passed such a reform measure, but Fox unexpectedly vetoed it, bowing to pressure from state governors who perceived that their share of Mexico’s oil revenue would be affected. Congress is renegotiating a revised fiscal reform formula.

The most controversial of the proposed reforms was one that advocated a constitutional reform to allow private investment in natural gas exploration and production. Ramírez Corzo had advocated the measure when the multiple service contracts were unveiled in December 2001 while he was E&P director.

Key reform driver

The most important oil field in Mexico-perhaps in all of the Americas-is Pemex’s offshore Cantarell field, which has been in production for some 25 years. Observers have predicted its inevitable decline in voices ranging from neutral to apocalyptic. Its 2 million b/d of oil output by one curve is expected to fall to 1 million b/d by 2010. Other curves see the decline as a gentler slope (Fig. 2).

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Pemex, meanwhile, hopes to raise production of the Ku-Maloop-Zaap (KMZ) fields to 800,000 b/d in the next few years. Even so, the decline of Cantarell will not be fully compensated by production increases in KMZ and Ek-Balaam (EB) fields.

López Obrador proposals

At a luncheon meeting in Houston in early 2005 a former Pemex executive said rhetorically, “Tell me three reasons why I should not believe that López Obrador will be the next president of Mexico in 2006.” At the time, his ratings in the polls were high, and he had a charisma that would force the Fox administration eventually to drop charges of illegal behavior in relation to an obscure land-development program, so there were few reasons to offer.

Since then, the sense of an inevitable López Obrador electoral victory in July 2006 has all but disappeared.

His proposals for the energy sector are summarized in a document, “50compromisos.doc” available on his AMLO website. The commitment numbered 22 concerns impacting the energy sector.

“We will modernize the energy sector without privatizing either the electric or the oil sector,” he states. “We will create greater value-added to the oil sector to create jobs. In 3 years we will cease to import gas and gasoline, and these products, together with electricity, will be sold at fair prices in the domestic market, and we will be competitive in the international market.”

Each section of the document consists of several paragraphs of background, outlook, and a list of his party’s proposals.

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While the details of the proposals go beyond the scope of this discussion, their justification is clear: The equivalent of nearly 90% of Pemex’s export earnings go toward the import of petroleum products and petrochemicals (Table 2).

Lajous’s critique

Lajous’s critique of the white paper by López Obrador and his team begins with the observation that the proposals deserve careful attention and a wide public debate. Lajous adds, “It should be recognized that presidential administrations, political parties, public officials, and experts have all failed to articulate the important questions about the direction of change that we wish and about the creation of [an informed] public opinion in relation to the problems that we really face. For these reasons, we should respond to the challenge presented by López Obrador contained in his proposals.”

The discussion that follows finds fault with most of the proposals for the oil sector. The only point of partial coincidence is that where López Obrador does not include the need for private investment in E&P, Lajous notes only that strategic alliances with IOCs are not needed for deepwater development. The text of the document is posted on energia.com.

Lajous finds particular fault with the proposals to achieve self-sufficiency in petroleum products and in particular the policy proposing to reduce natural gas demand in the electric power sector by encouraging the use of fuel oil.

Midstream investment?

Of the two Fox proposals that contemplate private investment in the oil sector, only the one that addresses private investment in midstream oil operations is new. At present, there is no regulator with authority over pricing or public tender activities that would be associated with such investments. In his Sept. 13 press briefing (posted on www.presidencia.gob.mx) then-Energy Minister Fernando Elizondo spoke of the need for an upstream regulator of the kind found in Norway and Brazil. It was a setback for the perceived seriousness of the Fox proposals that this official resigned only a few days after the announcement of the 10 proposals.

Absent a full disclosure of the terms of reference for a constitutional proposal to open nonassociated gas E&P to private investment, no conclusions can be reached as to the extent to which the proposal meets the minimum IOC requirements: reserves posting, independent market valuation of production, and compensation linked to market values.

Industry observers continue to debate the merits of Fox’s proposals. Some view them as a capitulation to the intense lobbying pressure by the Monterrey industrial groups, a sign that Fox has given up having his own vision for the energy sector.

If the submission of these proposals is in response to the market dislocations of Hurricane Katrina, the proposals dealing with private investment are tardy, given that the last year of his term begins Dec. 1. Still, if the effect of the proposals is to force the political system to debate real policy issues-a goal also sought by López Obrador and Lajous-then they will have served a good purpose.

Even so, some claim it’s unfortunate that the leader of “The Government of Change” should have taken a course in energy policy that they characterize as timid. Forcing his successors to debate policies that he should have formulated and executed himself is an accomplishment-and a big one in Mexico-but less than had been hoped for in the summer of 2000.

FOX ENERGY POLICIES, CONSTITUTIONAL REFORM PROPOSALS

Proposals related to market reactions to Hurricane Katrina:
1. A decree to reduce the September price of natural gas to $7.60/MMbtu to lower the impact of rising international prices.
2. Limitation of electric power tariff increases to 4% in 2006 (in his economic package sent to Congress)
3. Limitation of LPG increases to 4% in 2006 (also in economic package).
4. Continuation of subsidy program for residential natural gas consumers.
5. Energy subsidy programs for micro, small, and medium-sized companies.

Proposals related to structural change in the oil sector:
6. Constitutional changes to Congress that would allow private investment to complement State exploration and
production of nonassociated natural gas.
7. Modifications to the Regulatory Oil Law of 1958. If the proposal is to eliminate the restrictions of Article 6 it would be
a major change; if not, only cosmetic adjustments would be achieved. In his Sept. 12 message, Fox spoke only of
improving infrastructure and public safety in areas where Pemex operates oil or gas pipelines.
8. Diversification of natural gas supply sources. Fox alludes to LNG projects, but without reference to the controversial
issue of diversifying the index pricing of such supplies (which currently have US price indexes).
9. Subsidy programs to promote alternate energy sources, including wind-energy project La Venta III. (La Venta II is a
$100 million project currently under construction.
10. A commission of experts, researchers, and academic specialists to recommend improvements in the use of energy
sector resources and to propose solutions to increases in international energy prices.

LÓPEZ OBRADOR’S ENERGY PROPOSALS


1. To significantly increase public investment in the energy sector.
2. To increase proved reserves of crude oil and natural gas.
3. To maintain crude production and increase natural gas production.
4. To achieve the integration of the energy sector.
5. To reintegrate Pemex’s organization.
6. To expand the national refinery system.
7. To regain self-sufficiency in gasoline.
8. To regain self-sufficiency in natural gas.
9. To fully exploit the national electric power sector and diversify installed capacity.
10. To implement a policy of fair prices

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The author
Petroleum analyst George Baker is the principal of Baker & Associates in Houston (Energia.com). His firm also is publisher of Mexico Energy Intelligence. Baker has contributed articles on Mexico to OGJ since 1981.