22
Jul
2020

Taking back control: Mexico’s bid for energy sovereignty

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  • AMLO aims to “make Pemex great again” by market in its favour
  • However much-needed structural reforms at Pemex are not forthcoming
  • Privately-owned producers in upstream as yet unaffected by roll-back of reforms
  • Political atmosphere has “destroyed” appetite for foreign investment in Mexico

In May of this year, Mexican President Andrés Manuel López Obrador, commonly referred to by his initials AMLO, pushed through a sweeping set of measures ostensibly aimed at ensuring the reliability of Mexico’s national grid at times of low demand due to Covid-19.

The new laws essentially privileged Mexico’s national electricity company, the Comisión Federal de Electricidad (CFE), by blocking out – privately owned - renewable sources of energy from Mexico’s electricity system. The measures guarantee income for CFE, and indirectly benefits Mexico’s beleaguered national oil company, Pemex by prioritising electricity from the company’s oil and gas-fired thermal power plants, and designating a number of the company’s power plants as “must run,” on the grounds they are needed to balance the grid.

AMLO’s energy bill circumvented normal procedures, by passing into law without undergoing the normal notice-for-comment period. The unorthodox process prompted the resignation of César Hernández, the head of Mexico’s energy regulator Conamer.

While introduced as provisional measures aimed at ensuring the reliability of Mexico’s national grid, it remains unclear as to whether the measures are temporary or when they will end.

Critics claim the measures are partly aimed at boosting revenue for cash-strapped Pemex by boosting power sector demand for the company’s sulphur-heavy fuel oil – demand which has been hit in recent years by stringent International Maritime Organisation (IMO) shipping emissions regulation. This has been exacerbated by increased use of natural gas and renewables in Mexico’s power generation mix over the previous 20 years.  

In June, the AMLO administration further restricted the market for Pemex’s privately-owned wind and solar rivals, hiking the rates electricity generators must pay to use the CFE’s transmission system by 500-900%.

These measures were later reversed by a judge, who ruled that the risks to Mexico’s grid posed a lesser threat than the measures would do to competition. Yet despite the reversal, Nymia Almeida, SVP at Moody’s, tells Gas Matters that AMLO’s interventions created “a lot of noise” and undermined trust in Mexico’s institutional framework.

President AMLO, elected in 2018 on a mandate to keep gasoline prices low, has vowed to reverse the “neoliberal reforms” spearheaded by his predecessor, Enrique Pena Nieto, and make Mexico energy self-sufficient.

AMLO’s term in office comes as Pemex is in serious trouble. The loss-making national oil company, now the most indebted oil company in the world, was relegated to junk status by Moody’s in April, in reflection of the firm’s “high vulnerability to low commodities prices given its fragile liquidity position and excessive debt burden.”

All the while, as Pemex’s oil and associated gas production goes into decline, Mexico is becoming increasingly reliant on imports of natural gas from the US to meet its energy needs.

“For the recovery of sovereignty”

Pemex’s woes bode ill for Mexico’s government, which is heavily dependent on oil revenue (see box). Adrian Duhalt, postdoctoral fellow in Mexico energy studies at Rice University’s Baker Institute, notes that the Mexican government has sought to make up lost oil revenue by increasing the rate of tax collection across the economy, particularly from multinational firms. In 2018, Mexico had the lowest tax-to-GDP ratio among Organisation for Economic Co-operation and Development (OECD) countries, collecting as taxes just 16.1% of GDP. The OECD average is 34.3%.

In June, AMLO’s tax chief, Raquel Buenrostro, nicknamed the Iron Lady, said she would press charges against multinational companies that fail to pay taxes. The finance chief named the energy industry as among key debtors to the Mexican state.

Blunt tools

AMLO “wants to make Pemex great again,” says Duhalt. But “he is underestimating the size of the damage done to Pemex by previous administrations. What he is doing is not going to be enough. He is injecting capital into the company… [but] what Pemex needs is a major upgrade from inside out.”

One industry source agrees, saying: “Of course, injecting public money into companies, doesn’t mean those companies will grow.”

Duhalt notes that many market observers question the extent to which the AMLO administration has “the technical capability and understanding to implement change.”

Duncan Wood, director of the Wilson Centre’s Mexico Institute, describes the cash injection into Pemex as a “blunt tool”. He says: “He’s using a more surgical tool by adjusting the regulatory framework and making the investment environment unwelcoming for foreign capital, which he sees as levelling the playing field.”

Scorned reforms

AMLO’s energy overhaul was introduced as CFE was being forced out of Mexico’s electricity market by increasingly competitive renewables, at a time of low demand caused by Covid-19. CFE’s market dominance has been hollowed out over the past six years as a result of Nieto’s reforms: today CFE provides just more than half (54%) of Mexico’s electricity, with private companies providing the remaining share (46%).

The 2014 energy reforms also introduced private sector players into Mexico’s oil and gas sector for the first time since 1938. Mexico’s first round of auctions in July 2015 failed to attract much interest, with just two out of 14 shallow water oil and gas fields were sold. Both lots were sold to a consortium made up of Mexican firm Sierra Oil and Gas, UK independent Premier Oil, and US company Talos Energy.

The second round of auctions was more successful, selling three out of five shallow water fields to various European, Latin American and US firms, including Italian multinational Eni and Fieldwood Energy LLC. In a third auction of onshore acreage, all 25 lots were sold, mostly to local firms, while the “fourth auction was much, much better” Almeida says. In total, 107 contracts were awarded to more than 70 companies between 2015-2018.

As of December 2019, the private sector was producing around 47,000 barrels/d – around 2.5% of Mexico’s total. Soon after entering office in 2018, ALMO suspended all new oil and gas auctions for three years but said existing contracts would be respected.

Pemex has a near monopoly on Mexico’s gas industry and produces 94.85% of Mexico’s gas, equivalent to 3,609 MMcf/d, according to figures from Natural Gas Intelligence.  

Almeida says Mexico’s oil and gas assets are “of a high quality” but “if the institutional strength is not there – then it will raise concerns.” Yet she notes that in spite of this, Mexico’s private operators have not yet registered any official losses.

“We have no factual evidence that any project in Mexico has lost any cash value, but there is a lot of noise and uncertainty,” she adds.

Wood notes that in the longer term, AMLO hopes to “recentralise control” over Mexico’s electricity sector and “reverse the reforms of 2013,” as part of his vision for Mexico’s future. In fact, AMLO is “obsessed with the energy sector”, according to one industry source.

Wood believes the AMLO administration doesn’t like the fact that renewables are so competitive, doesn’t like CFE being pushed out of the market, and doesn’t like the idea of private companies playing a role in Mexico’s electricity sector.

He says AMLO’s approach has destroyed “any kind of enthusiasm to invest in Mexico.”

“Why would anyone want to invest in Mexico when there’s huge doubts about the regulatory framework?” he asks. “The lack of legal certainty is a killer.”

Reform or revolution?

AMLO’s energy overhaul may be partly aimed at boosting Mexico’s refineries, which produce large amounts of fuel oil with a high sulphur content of 4%. This product, which accounts for around a quarter of the refineries’ output, has struggled to find a market in the shipping industry – the main consumers of heavy fuel oil - due to IMO regulations that limit the sulphur content of fuel oil in shipping to 0.5%. “AMLO’s solution is to burn it in Mexico’s thermal generation plants,” Wood says, an allegation that has been echoed by commentators elsewhere but firmly denied by CFE.

In fact, fuel oil’s demise in the power sector has been aided in no small part by the rise of natural gas. In the first decade of the millennium, fuel oil’s share in Mexico’s power mix dropped sharply from 61% in 2000 to 21% in 2010, as the share of natural gas jumped from 20% to 55%.

This trend continued at a slower pace over the following decade. As of 2018 natural gas supplied 60.3% of Mexico’s electricity, while oil provided just 10.5%, according to figures from the IEA. Currently, just 3.2% of state-owned CFE’s power is generated using fuel oil, while 37% is produced using natural gas.

Meanwhile, CFE has a monopoly over Mexico’s transmission grid, which forms the meat of the AMLO administration’s objection to renewables: variable renewables in large quantities threaten grid stability, for which CFE must pay the price without being compensated.

Indeed, Mexico’s wind and solar capacity has grown rapidly since 2013. Yet together, wind and solar provided just 4.8% of Mexico’s total electricity in 2018. Of this amount wind generation is dominant providing, more than three-quarters (75.5%) of Mexico’s wind and solar electricity, with solar providing the minority share (24.5%). Altogether, clean forms of energy including nuclear, biofuels, hydroelectricity, and renewables, supplied 20.6% of Mexico’s electricity in 2018. 

In June, the AMLO administration said they aim to diversify Mexico’s power generation mix, by boosting “stable” sources of power including natural gas, hydro and geothermal.

Duhalt said natural gas will continue to play a “critical” role “as a source of power generation.” He notes that the start-up of Mexico’s Whalajara gas transmission system, which connects demand centres in Mexico with the Waha hub in Texas, will push up imports of US gas.

Yet AMLO appears to view Mexico’s refineries as a ticket to energy independence and self-sufficiency. Mexico currently imports nearly 70% of its gasoline, which may explain AMLO’s preoccupation with fixing Pemex’s loss-making refining business in a bid to boost output.

Pemex owns six refineries in Mexico, which Moody’s estimate ran at just 36% capacity in 2019. By comparison refineries run by international oil companies (IOCs) typically operate at around 87-92% capacity.

But experts believe this is the wrong approach. “Pemex should eliminate its refining division, which loses billions of dollars every year,” says Wood. “Everyone would benefit because you’d have cleaner, more efficient, better run refineries.”

Instead, even as prices linger at historic lows, the AMLO administration has launched construction of an USD 8 billion refinery in the port of Dos Bocas, in the President’s native state of Tabasco, pushing ahead with controversial plans for a refinery with capacity of 340,000 barrels/d first announced in 2018.   

All the while, Mexico continues to import most of its natural gas. While 62% of overall demand is met with imports, when Pemex is taken out of the equation - both a large producer and consumer of natural gas – the wider Mexican economy meets 90% of demand via imports through pipelines from the US and LNG. Mexico’s increased reliance on imports comes as demand continues to rise, whilst production goes to decline.

“There is no way to increase natural gas production in the short term,” meaning Mexico will have to rely on imports from the US, Duhalt says.     

Investing in natural gas would be a sensible option,” for improving Mexico’s energy security in the long term, he adds. “One avenue would be to develop Mexico’s shale reserves.”

After China, Argentina, Algeria, the US and Canada, Mexico – with 545.2 Tcm of technically recoverable shale – is estimated to have the sixth largest shale gas reserves in the world, according to the US Energy Information Administration. Yet in June 2019, AMLO blocked Pemex from fracking in Mexico, by vetoing a decision made by the National Hydrocarbons Commission (CNH).

The government may need to allow Pemex to downsize. Pemex should simply “focus on what it does best”, says Wood, adding that Pemex is “really good at shallow water exploration and production and it’s really good at onshore production in conventional fields.”

This would, however, require the government to nationalise some of Pemex’s debt. “Create a new national oil company (NOC) where you split ownership between the state and private investors, he says. “Let that new company do the risky work and give it the freedom to do so.”

The new company would have access to private capital markets because it would not be burdened by debts and labour liabilities, including its “crippling” pension overhang, he notes, and would have the additional benefit of creating competition between the two NOCs.

Political economy

Duhalt agrees: “Pemex does not lay people off.” Sons of Pemex employees can even “inherit their father’s jobs. These kinds of situations are heavy on the company’s efficiencies.” 

Almeida says Pemex’s current situation is comparable to those faced by Petrobras and Ecopetrol in recent years. “The formula for their success was in making the hard decisions,” she says. “It was focusing on certain businesses, pulling out of others, firing people. Doing everything a private company would do.”

Yet political pressure prevents the government from implementing change. The government is under pressure to secure the votes of people in oil producing areas ahead of Mexico’s 2021 midterm elections, meaning they are reluctant to lay people off.

The government “is not going to go against their own people in the oil regions,” Duhalt says. “It’s not about the economics of the company, it’s about the political games you can play.”

Almedia agrees: “It does not seem like this government will fire people, or focus on E&P, which is the only sector of Pemex that makes money. All these things don’t go with the government’s agenda. It’s hard to be successful with this rigid agenda.”

This situation leaves the Mexican government in a bind. While it relies on its cumbersome NOC as a major stream of revenue, the indebted firm is in a state of continuous decline, made worse by the crisis of Covid-19.

Pemex needs to be overhauled. Yet political considerations hinder any moves towards major reform, leaving the government with few options to improve Pemex’s position. As a result, the government has sought to pump money into Pemex and kill off the competition as a means of recentralising control.

At the same time, there is little chance new investors will even be allowed entry into Mexico’s energy sector, as AMLO aims to restore Pemex’s hegemony by blocking out private players altogether. All this means that there will probably few opportunities for private investors in coming years – at least until AMLO comes up for re-election in 2024. - LG

Contact the editor:

Rachel Parkes
[email protected]

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