The past, present, and future of energy in Mexico: prospects for reform under the Pena Nieto administration.

• Author: Samples, Tim R.

1. INTRODUCTION II. THE PRESENT: PEMEX IN THE TWENTY-FIRST CENTURY A. Declining Production Since 2004 B. Consequences of Declining Production C. Reasons Behind Declining Production: the "Pemex Situation". D. Solutions to the Production Conundrum III. THE PAST: PETROLEUM LAWS IN MEXICO A. The Constitution of 1917 B. The Expropriation of 1938 and the Origins of Pemex C. The Petroleum Law of 1958 D. Pemex Since the 2008 Energy Reform IV. THE FUTURE: CURRENT OUTLOOK FOR ENERGY REFORM A. The Elections of 2012 B. Potential Models for Reform in Mexico C. Outlook for Reform Under Pena Nieto "Wisdom lies neither in fixity nor in change, but in the dialectic between the two."

   "La sabiduria no esta ni en la fijeza, ni en el cambio, sino en la dialetica entre ellos."

   --Octavio Paz, The Monkey Grammarian

1. INTRODUCTION

   Petroleos Mexicanos (Pemex) is Mexico's national oil company. (1) Pemex is simultaneously known as the "cash cow" and "sacred cow" of Mexico. (2) As a cash cow, Pemex is often responsible for more than one-third of the Mexican government's revenues. (3) As a sacred cow, Pemex is a profoundly important symbol of Mexican sovereignty and independence, on par with cultural icons like the Virgin of Guadalupe and the Mexican flag. (4) But these dual roles are increasingly at odds. Pemex is burdened by the enormous tax obligations of a cash cow, yet--as a sacred cow--is handcuffed by strict constraints under Mexican law. (5) Pemex is currently struggling to balance these roles while also adapting to a challenging and unfamiliar production environment. (6)

   The future of Mexico is closely tied to the future of Pemex. Pemex is the largest oil producer in Latin America and is among the four largest producers in the world. (7) Pemex is wholly owned by the Mexican government and has a monopoly over many facets of the Mexican petroleum industry, including the exploration and production of hydrocarbons. (8) As a fiscal engine of the Mexican state--responsible for thirty to forty percent of the federal government's income--Pemex affects the lives of nearly all Mexicans. (9) Revenue from Pemex funds public spending on everything from education and health care to public infrastructure and poverty alleviation programs. (10) Pemex is also a major employer of Mexican citizens and is responsible for the country's energy security. (11)

   Internationally, the future of Pemex is strategically and commercially significant. Mexico is a key energy partner of the United States. (12) Mexico is not a member of the Organization of the Petroleum Exporting Countries (OPEC), and remains among the top three suppliers of U.S. foreign oil imports, alongside Canada and Saudi Arabia. (13) As important as Pemex is from a supply perspective, the company's role as the financial bedrock of the Mexican government is even more important in the current era of U.S.-Mexico relations. Pemex is critical to the stability of the Mexican government, which affects the United States in many important respects. Finally, the international energy industry--including companies from Asia to Europe, and all over the Americas--is keenly interested in investing in Mexico's energy sector. (14)

   Not by coincidence, Mexico's newly elected president, Enrique Pena Nieto, identified energy reform as the "signature issue" of his administration. (15) Pena Nieto has committed himself to achieving the meaningful reform that eluded his predecessor. (16) After oil production in Mexico dropped by a quarter in just a few years, then-president Felipe Calderon passed the 2008 Energy Reforms aimed at modernizing Pemex and providing avenues for private participation in the energy sector. (17) Despite many important changes, the 2008 Energy Reforms did not address fundamental obstacles to attracting the foreign investment that Pemex needs. (18) Pena Nieto now stands as the next Mexican president to attempt to solve the Pemex situation.

2. THE PRESENT: PEMEX IN THE TWENTY-FIRST CENTURY

   1. Declining Production Since 2004

      Mexico has experienced a major decline in oil production in recent years, losing roughly a quarter of gross production while dropping from 3.4 million barrels per day (bpd) in 2004 to 2.5 million bpd in 2011. (19) Roughly eighty percent of Mexico's oil fields are currently in advanced or declining stages of production. (20) In 2012, ninety percent of oil production came from fields that were discovered over twenty years ago. (21)

      In recent years, production has stabilized at around 2.5 million bpd. (22) Despite significant declines, Mexico remains the seventh largest producer of crude oil in the world, (23) and among the most important non-OPEC producers. (24) However, Mexico has also become a major consumer of petroleum. (25) Due to falling production and growing consumption, recent studies suggest that Mexico could be a net importer of oil within a decade, an alarming scenario for the Mexican government. (26)

      To a large extent, declining production is related to the aging of Mexico's offshore super-giant, the Cantarell field. (27) Discovered in 1976 in the shallow waters of the Bay of Campeche by a local fisherman named Rudesindo Cantarell, after whom the field is named, Cantarell is the largest field ever discovered in Mexico and one of the largest in the world. (28) During peak years, production at Cantarell was surpassed only by Saudi Arabia's super-giant Ghawar field. (29) Cantarell has been a boon for Mexico, generating roughly $500 billion in revenue since production began in 1978. (30)

      Since 2006, however, production at Cantarell has dropped by seventy-four percent. (31) Cantarell accounted for an amazing sixty-three percent of Mexico's crude oil production in 2004, but fell to just twenty percent by 2010. (32) For decades, Pemex could rely on Cantarell as a huge supply of readily available oil in a familiar geological formation with relatively high rates of recovery. (33) With the aging of Cantarell and with many of Mexico's largest fields in decline, the future of Mexico's oil industry now lies in the complex heavy oil reserves of Chicontepec and costly deepwater reserves in the Gulf of Mexico. (34) As Mexico's Ministry of Energy (SENER) stated in its most recent national strategy plan for 2013-2027, the era of "simple" exploration and production is over. (35)

   2. Consequences of Declining Production

      Declining production in Mexico has far-reaching domestic and international consequences. On the domestic level, there are crucial economic and social ramifications. (36) Mexico depends on oil revenues for everything from social assistance programs to counternarcotic operations. (37) Pemex export revenues were even used as collateral for a $48.8 billion multilateral rescue loan package to stem a financial crisis in 1995. (38) The importance of production is evident in the Pemex budget for 2013, which allocates the lion's share of a record $25.3 billion budget to upstream activities. (39)

      Although the Mexican economy is less dependent upon oil than during the catastrophic oil shocks of the mid-1980s, the fiscal health of the government is still closely tied to Pemex. (40) Pemex is arguably the most important company in Mexico and--mainly through taxes and direct payments--has historically been responsible for a remarkably large portion of the Mexican government's revenues while compensating for one of Latin America's weakest tax collection regimes. (41) In 2011, even with oil production and exports in decline, the oil industry provided thirty-four percent of the Mexican government's total revenues and accounted for sixteen percent of Mexico's export earnings. (42)

      Mexico's energy industry also has broad implications for U.S.-Mexico relations. (43) As the third largest supplier of foreign oil to the United States and the third largest producer in the Western Hemisphere, Mexico is a key partner in the U.S. energy trade. (44) Yet, from the standpoint of U.S. security interests, the role of Pemex within Mexico--as a cornerstone of the government's fiscal stability--has now eclipsed the company's importance as a source of imported oil. (45) That is due to the immense importance of the energy industry to the fiscal health and stability of the Mexican state. (46) In addition to domestic programs, Mexico also relies on Pemex revenue to cooperate with the United States on trade, security, migration, and other international issues. (47)

   3. Reasons Behind Declining Production: the "Pemex Situation"

      1. A Heavy Tax Burden

         Despite being the world's third largest oil-producing company, Pemex has been operating at a loss in recent years. (48) In 2011, Pemex lost $6.5 billion on sales of $111.5 billion. (49) Pemex is burdened by an immense fiscal obligation to the Mexican state, which typically amounts to well over half of the company's revenues. (50) In 2011, payments from Pemex hit a record high of $62.6 billion, representing 56.2% of the company's total revenues. (51) Pemex investment budgets have been underfunded for decades. (52)

         Recent reforms allowed Pemex to prepare its budget without direct supervision from the Ministry of the Treasury, but financial plans remain subject to caps imposed by Congress. (53) Even now, the long-term sustainability of this financial model is increasingly in doubt. (54) Alluding to these issues, a former director of Pemex recently lamented that the company is "horribly run," suffering from an emphasis on immediate returns at the expense of long-term gains. (55) More recently, problems with oil theft have exacerbated the financial picture by costing Pemex more than one billion dollars per year in losses. (56)

      2. Technical and Operational Deficiencies

         Pemex is now hobbled by factors beyond financial burdens. (57) Decades of prioritizing short-term revenues have shortchanged spending on exploration, strategic reinvestment, technology, research and development, and infrastructure. (58) For years, Cantarell disguised these deficiencies. (59) In a...