Mexico's price controls

Sept. 23, 2013
The Mexican government has left an important question open in its historic effort to transform the state-centered oil and gas business. It sets oil and gas prices and has said nothing about stopping the practice.

The Mexican government has left an important question open in its historic effort to transform the state-centered oil and gas business. It sets oil and gas prices and has said nothing about stopping the practice. A continuation of price administration would compromise the liberalization President Enrique Pena Nieto seeks for oil, gas, and electricity. But leaving the issue in suspense might be wise.

Resource nationalism shows no sign of weakening in Mexico, where it has driven politics since nationalization of the oil industry in 1938. Yet the government recognizes Mexico is missing the opportunity to develop rich oil and gas potential in deep water and in unconventional reservoirs onshore. Petroleos Mexicanos, the state oil and gas monopoly, can't afford large investments. The outsize expenses of a bloated bureaucracy and heavy claims by the government devour its revenue. And with joint ventures by private operators precluded by law, Pemex's access to technology is limited to what it acquires under contracts with service providers working on existing projects.

Watching northern booms

Pena Nieto's government thus must watch booms in deep water, low-permeability reservoirs, and oil sands expand spectacularly to Mexico's north while Mexican production, limited to mostly mature conventional plays, declines. The business regime must change.

But Pena Nieto, head of the Institutional Revolutionary Party (PRI), is moving cautiously. Another party, the National Action Party (PAN), has proposed more-aggressive reform. A third group, the Party of the Democratic Revolution (PRD), opposes all but limited change. Together, the PRI and PAN control enough votes in Congress to pass essential constitutional changes.

Speakers at a Sept. 13 seminar held in Houston by the law firm Mayer Brown described the president's strategy as politically shrewd (OGJ Online, Sept. 13, 2013). They pointed out his proposal returns relevant parts of the Constitution to nostalgic wording put in place after nationalization of the oil industry, simply expunging laws passed later. The plan keeps ownership of oil and gas resources with the government, precludes concessions, and leaves to Congress the making of energy policy and determination of participation terms for outsiders. Pena Nieto's approach thus honors nationalization, confines the initiative to constitutional reforms requiring two-thirds votes in Congress while essential support is in place, and leaves more-contentious change to legislation needing simple majority votes.

With privatization, as one of the Mayer Brown speakers noted, "still a dirty word" in Mexico, politics of the secondary legislation will be tricky if Pena Nieto's constitutional changes are passed. Price controls could become at least a lever of political influence if not an element of actual reform.

In a recent article, analysts at the Federal Reserve Bank of Dallas traced gasoline and diesel prices set monthly by the Mexican government since 1995. Until 2006, those prices exceeded costs of production. Since then, prices have been below production costs, the fuels effectively subsidized. Varying greatly in that period, subsidization values have averaged about 40¢/gal for gasoline and 59¢/gal for diesel, write Michael D. Plante, research economist, and Amy Jordan, research analyst in the Dallas Fed's quarterly Southwest Economy. Since 2010, the government has gradually increased fuel prices, aiming to remove the subsidies. The effort brought gasoline and diesel prices to near global parity this year without provoking major political unrest.

Convenient tool

With Mexican consumers lately accustomed to market values, the government might profitably see price administration as additional reform worth pursuing. Plante and Jordan pointed out subsidies are costly to governments, help the wealthy more than the poor, and aggravate air pollution by stimulating fuel use. They recommended replacing fuel subsidies with targeted payments to the poor. Doing so would broaden and strengthen the reform program under discussion.

Chances are better politicians will find control of fuel prices too convenient a tool to surrender during a political struggle. Indeed, price suppression might ease opposition to other reforms. Such a tradeoff would be better than failure to change anything. For Mexico, status quo means losing ground.