Mexico’s Faltering Round One: Long-Term Implications
With all the big waves this deal with Iran is making this week, I thought I would balance things out a bit with an offering from the other hemisphere and write a little round-up on Mexico’s re-emerging market, where it is today, and where it’s going.
In August of 2014, with a good deal of fanfare, Mexico boldly amended its constitution and in doing so re-opened its languishing oil and gas industry to foreign investment. But before the last bits of the confetti that had fallen from the ceiling in August had settled to the floor, the oil price left the $100bbl range and it hasn’t been anywhere close since. Given the collective despair the low price has wrought market-wide, Mexico’s re-debut is sputtering out of the gate.
The long awaited and somewhat ballyhooed Round One is well under way, and participation has been lackluster. Mexico’s national commission on hydrocarbons, CNH, has been justifiably concerned about transparency and has installed rigorous procedures to assuage investor concerns about corruption. In doing so, however, they created such a restrictive set of processes around their data room for the round that many companies couldn’t get comfortable enough with the prospects to justify their perceived risks. Adding to all of this, some aspects of the reform that seemed reasonable around $100bbl appear less so today. A sliding scale on royalties left many justifiably concerned that they will get very little of the upside their technology brings. Furthermore, there is a “parent-provision” that stipulates all bidding groups must have one partner act as a guarantor – a provision that has been perceived as excessively burdensome.
In response, several major pre-approved bidders have pulled out of Round One. Noble Energy, PTT E&P, Ecopetrol, and Glencore Plc pulled out this week, and somewhat surprisingly they were joined in their withdrawal by PEMEX. This leaves Round One participation at a disappointing 17 companies, and at least one Mexico expert I spoke with on Monday confidently declared, “more will follow.” This same expert explained, “Mexico wanted to follow the example set by Brazil, but this opening reminds me more of Colombia, who got it right, but only eventually.”
So if the opening has fallen short of the heady expectations of a year ago, it’s worth thinking back to the political and social context of that time, and what this lackluster launch might mean for the future. In case it was lost on anyone, the constitutional reforms that were ultimately passed by President Nieto and his party, the Institutional Revolutionary Party (PRI), were not broadly popular – especially in many of the rural areas where any onshore activity will likely occur. The Party of Democratic Revolution (PRD) is the party of the campesino – Mexican peasant-farmers who occupy large swaths of the country’s central and eastern regions. In the months leading up to the amendments, campesinos were actively protesting the reform across the country’s interior as concerns over land-use arose. Provisions in the amendments granting priority in land-use to hydrocarbon exploitation have aggravated these tensions.
To counter this opposition, and in a $100bbl price environment, Nieto and the PRI pointed convincingly to the prospects for all Mexicans to share in the abundant new economic rents that would accrue with the modernization and expansion of their struggling industry. But if Round One is any indication, for reasons both related to global economics and the way Mexico has structured the process, the political IOU that was used to carry these amendments may fall well short. The less this opening proves effective in convincing the rural interior that they got a good deal after all, the more likely we are to see the kind of disruptive grassroots community opposition that could make foreign participation even less attractive than it is today.
CNH seems well aware of this. I have attended several events here in Houston over the past few months where CNH delegates were present and answering questions, and a lot of the enthusiasm that animated them a year ago has subsided. They have answered the questions dutifully, and are still saying positive things, but the twinkle has gone from their eye. Most telling, in two recent Baker Institute meetings I attended on Mexico’s opening, and without prompting, Mexican officials have acknowledged and even warned that companies will be at the front-line in what is likely to be an acrimonious internal struggle for some time.
Looking to the future, we can expect Mexico to learn some hard lessons from this Round One experience and relax some of the more onerous provision in the current structure. There might even be some compensatory overreach in the other direction, which might have its own set of prickly consequences. But, to drop an old cliché: “you never get a second chance to make a first impression.” Given the hotly contested political environment and the optimistic predictions that gave rise to this reform, this first impression might have breathed some permanent life into the rural-agricultural community’s opposition to Mexico’s opening. The “we told you so,” narrative is already in play, and soon this will go from a matter of the head to a matter of the heart in many of the people who have felt betrayed by reforms in the first place. The difficulty for foreign companies with an eye on Mexico is that, especially in the onshore blocks, many of those feeling betrayed comprise the very communities that will surround their investments.
It’s worth keeping an eye on, and for companies considering a move into Mexico the potential for significant conflict with local communities will be worth assessment and consideration. The Mexican Government and CNH are in a very difficult spot at the moment. With Round One struggling they appear likely to fall short on some of their promises of economic benefit that they used to usher in this reform. Furthermore, in an attempt to improve participation in subsequent rounds they are likely to have to roll-back some of the stipulations that their opposition party saw as fundamental safeguards. All of this will ultimately increase the surface-risk environment, which is already problematic, and prove another barrier to foreign investment.
I am actually optimistic about Mexico in the long-run, but I do think it’s going to be a difficult road and that the companies who ultimately succeed there will have to prove their mettle in managing the surface risks as well as the technical ones. In spite of rural opposition to liberalization in Mexico, extended economic participation and modernization of their energy sector may provide the best hope yet for an improved life in some parts of the country that struggle today. But between here and there, oil companies participating in Mexico may find themselves running a bit of a social gauntlet made more precarious by a disappointing Round One.
Aurthor: Scott Platzer