Change could be coming to Mexico’s energy markets sooner than later. The optimism surrounding the August announcement by President Enrique Pena Nieto is widespread, with the country’s Congress expected to push the proposed reforms through and bring Pena’s vision to reality.
Pena is not the first elected official to try to reform what some say has become a burden for the Mexican government. It has been nearly eight decades since the government gained full control of the country’s growing energy sector, which the U.S. Department of Energy projects could become a net importer by 2020.
Since 1938 the Mexican government has had a monopoly on the energy sector with its oil company, PEMEX. Despite a dramatic increase in the government’s oil spending to $20 billion a year from $4 billion just a decade ago, there has been a persistent decline in output from 3.4 million barrels a day to about 2.5 million.
The key element, according to market analysts, of President Pena’s plan is that it treads a middle path. It moves to break the PEMEX monopoly, but it does not grant concessions, like the global oil companies would like. Instead, Pena’s vision of energy reform is calling for profit and risk sharing contracts. Oil companies would be paid in cash for their services, not given oil or ownership of some fields, as is the case in other countries.
State of the Sovereign
Mexico’s current rating of BBB by Standard and Poor’s is one notch below both Moody’s and Fitch Ratings, respectively, and S&P adopted a positive outlook on the country in March. It appears that the market had been in some way anticipating an energy reform announcement in recent weeks. The Nov. 12 Commitment of Traders report from the CFTC showed the number of open peso futures positions has nearly doubled since June. (from 67,000 contracts at the end of June to 122,000 contracts on Nov. 12).
OpenMarkets brought together market analysts and regional economists that have their eyes on Mexico to discuss the proposed reforms and what a more open energy sector means for the country’s financial sector, including its FX and equity markets.
- Benito Berber, Senior Latin America Strategist, Nomura
- Marco Oviedo, Chief Economist, Mexico, Barclays
- Win Thin, Global Head of Emerging Markets, Brown Bothers Harriman
What does the potential energy reform proposed by President Pena mean for Mexico’s markets, particularly the derivatives market, MexDer?
Thin: I would think it is very positive for growth, and thus for Mexican equity markets. Reforms are long overdue, as the current regulatory backdrop has resulted in very little investment and exploration in the energy sector. Opening up this sector will bring in the needed investment and R&D to help reverse the decline in Mexico’s oil production and reserves. Oil output has dropped from nearly 4 million bbl/day back in mid-2000s to under 3 million bbl/day currently. Reserves have dropped from 56 billion bbl in 1990 to barely 10 billion currently.
What is the general consensus? Will proposed reforms make it through Mexico’s Congress?
Thin: The Pact for Mexico, which all three major parties have agreed to, has led to an unprecedented period of cooperation within Congress. There will have to be some compromises, but we think the Pact will hold and legislation should pass.
Berber: The most likely scenario is that Congress approves the constitutional reform that would allow private investment in the oil and gas sector by year-end.
Ovideo: The energy reform will likely be approved with a coalition of the PRI and the PAN. However, the government will have to fulfill the demands of the PAN in terms of electoral reform before getting the full support to it.
As a developing nation, energy reform could put Mexico in a group of global energy leaders, especially within the emerging markets. What does this mean for competition?
Thin: Increased output stemming from the reforms would keep Mexico part of the growing North American bloc of energy producers. The U.S., Canada, and Mexico should see energy output grow over the next several years and should help keep global energy prices at manageable levels. Growing oil production from stable North American sources should also help limit the effects of supply disruptions from the more politically volatile Middle East.
Ovideo: The faster development of the energy sector in Mexico could be synchronized with the developments in the United States. We could start talking about the NAFTA energy bloc. Also, the manufacturing sector will become more competitive improving the outlook for foreign direct investment (FDI) and market expansion for Mexican manufacturers.
Lastly, what impact, if any would energy reforms in such a large country mean for the currency and regional FX markets?
Thin: Increased foreign investment in Mexico should bring inflows of investment and capital. That should tend to strengthen the peso.
Ovideo: I would expect a real appreciation of the peso, once we observe positive developments in the FDI and growth sides derived from the energy reform, likely to happen starting in 2015 or 2016 (implementation will take time). Moreover, as the U.S. Dollar will strengthen, the Peso will follow as both economies are highly integrated.
Berber: Clearly, the energy reform is positive for the currency to the extent that it will likely trigger an important increase in FDI in the next five years. I estimate that FDI could increase between 20 percent and 100 percent in the next five years. However, not all the money will enter the economy because the majority of the providers are foreign (for example companies that rent specialized machinery are foreign). Also to the extent that the economy will likely grow faster, the reform has the potential to attract portfolio inflows.