Mexico Is on the Brink of a New Oil Rush – If Their Politicians Allow It

Unless Mexico invites in foreign oil investors soon, a country with the world’s second-largest untapped crude reserves could become a net energy importer. Susana Gonzalez/Bloomberg via Getty Images

It's crunch time for the Mexican government's heroic struggle to end one of the world's most enduring monopolies and shake up its economy in the process.

President Enrique Peña Nieto wants to end his first year in office by changing the country's constitution and opening up one of the most lucrative untapped energy sources in the world to outside investors. His government predicts the move could boost the Mexican economy and global firms hope for lucrative oil and gas extraction contracts.

But first, Peña Nieto must jump over several hurdles that politicians on his left flank keep throwing his way, including, possibly, a referendum that – if current polls are to be believed – could sink the whole enterprise.

Peña Nieto is optimistic. The Mexican senate made the initial legislative steps this week that, once completed, will repeal constitutional provisions dating back to 1938, when President Lázaro Cárdenas nationalized the country's oil industry. New laws will also set up the rules allowing outsiders to compete with the government-owned oil monopoly over the exploitation of Mexico's oil and natural gas.

The government would like to complete the legislation process before next week, when the Senate and the lower house adjourn for the end-of-year vacation. But officials indicate they may extend the session beyond December 15 so the complex legislation would be passed this year.

But will the new president's attempt at revolutionizing the energy market be enough to lure the big energy investors that Mexico so desperately needs? It all depends on the final details, say oil analysts and Mexican politicians.

The president "should go the whole nine yards and do as much as politically possible" to get investors in, said New York University's Jorge Castañeda, a former Mexican foreign minister and an early supporter of liberalizing the energy market. However, he said, there are some potential political traps that may scare off the big oil firms, including, possibly, a referendum that could rescind the new legislation.

The government is confident Peña Nieto can overcome such problems. "In three years, none of this will be an issue. Everything will be working fine," a Mexico City official told me, asking for anonymity because of the delicate state of the political negotiations.

Legislators from Peña Nieto's left-of-center Institutional Revolutionary Party (PRI) and its main opposition, the center-right National Alliance Party (PAN), say that between them, along with the small Green Party, they control two thirds of the Mexican parliament. That is exactly the majority they need to change the three constitutional articles that currently give the government-owned Petroleos Mexicanos sole extracting rights for the country's oil and natural gas.

The Pemex monopoly, plagued by corruption, political favoritism, excessive union demands, and aging technology, has turned Mexico, a once-world leading energy powerhouse, into a second-rate oil manufacturer. Crude output in 1984 was 3.4 million barrels a day. This year it is a little more than 2.5 million barrels.

The fracking revolution has all but evaded Mexico and deep-water drilling technology lags far behind. As a result, a country with the world's second-largest untapped crude reserves, according to some estimates – behind only the Arctic Circle – could soon become a net energy importer.

Pemex CEO Emilio Loyoza, a savvy veteran of several U.S. and European international business firms, knows that outsiders need to come in before Mexico can tap its potential. "To increase production in Mexico, more investment is required, [and] one way to do this is to share the investment between other companies and Pemex," he told the Mexican congress last month.

According to Pemex estimates, Mexico needs an investment of $60 billion a year to reach its potential – double the current investment. The government estimates that opening its energy market to competition would lift economic growth by 1 percent.

Spokespersons for Exxon Mobil, Chevron, and Royal Dutch Shell declined comment as legislation is pending, but they and other major energy players with an eye on huge untapped reserves and handsome profits are avidly following the political drama. To lure such investors in, however, Peña Nieto first needs to convince them his legislation will not only be lucrative enough, but that it does not contain any hidden tripwires that could threaten their investment at a later date.

This week's "ambitious" steps in the Mexican senate represent "a very promising start," said George Baker, a Houston energy analyst specializing in Mexico. But it is going to be hard to assess exactly how attractive the legislation will be for investors before it has completed passage and all the details are known, which is probably by next year, he said.

If the government takes 60 percent of the profit, while investors get 40 percent, they would likely come in, he said. But "a ratio of 90 to 10 wouldn't be attractive."

"Several months will be required for the enabling laws to be drawn up and for the first projects to be tendered," said David Shields, a Mexico City–based independent energy analyst. "It will probably require about a year, perhaps more, for the first projects to be awarded and the first contracts to be signed." Potential investors will compare conditions in Mexico with those in other countries before jumping in, he said.

Back in August, when Peña Nieto was still hoping to enact the energy reform with the support of Mexico's left, he planned merely to allow foreign investors to share oil profits with the government. This month, after making an alliance with the market-oriented PAN party, the proposed legislation has grown more attractive for investors, giving them a share of the production rights, or even "concessions" – a system in which foreign firms own parcels of oil properties while paying royalties to the government.

According to Castañeda, the former foreign minister, PAN legislators know that once the constitutional changes pass both houses, they would lose all the political leverage they now have, as the PRI would no longer need their votes to get a two-thirds majority. They are therefore trying now to extract as many pro-market concessions as they can.

But many PRI members oppose such moves. They also fear the reaction of leftist parties, which have mounted street protests and acts of civil disobedience in an attempt to stop the oil reforms altogether.

This week the Mexican lower house passed a bill authorizing a national referendum on major issues if 1.6 million signatures are collected. Left-wing legislators say they have enough signatures to challenge Peña Nieta's new law, and according to polls up to 60 percent of Mexicans would vote it down in a referendum. A former left-wing presidential candidate, Andres Manuel Lopez Obrador, recently wrote a letter to several of the big oil companies, warning them that if the public votes the oil reforms down, foreigners would lose any investment they had made in Mexico until that time.

Unless the government finds a way to avoid holding the referendum, the government do it "as soon as possible" rather than wait until it is too late, said Castañeda. But a government official scoffed at the prospect. "Lopez Obrador can say what he wants, and he sure has, but we have a solution" for the constitutional impasse, he said, but declined to specify.

Passions over Mexico's buried national treasure run high, which is why, despite declining production figures and the loss of government revenues, ending the government oil monopoly has become Mexico's political third rail. When the PRI lost the presidency in 2000 for the first time after 71 years in power, it still could muster enough congressional votes to block any PAN reform attempt. Only after Peña Nieto, representing a new and more market-oriented generation of PRI leaders, recaptured the presidency last year, could oil reform be envisioned.

But it was Cárdenas, a PRI stalwart, who back in 1938 stunned international oil giants by nationalizing oil and confiscating their profits. No wonder that despite the significant profit potential, outside investors remain very careful before jumping back into Mexico.

Follow Benny Avni on Twitter: @bennyavni

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