Interview with Duncan Wood, Director of the Mexico Institute at the Wilson Center

As the 2019 Mexican Energy Forum approaches, Duncan Wood, Director of the Mexico Institute at the Wilson Center, joined us to discuss emerging challenges and engage in predictions about future trends in the Mexican energy industry. Duncan will be leading a panel discussion at this year’s forum and will be among an inner circle of key industry leaders sharing discourse and debate in Mexico City this June.

The Mexican government’s latest push for complete independence from outside involvement in the energy sector has left many wondering if the country has the funding and natural resources available to become self-sufficient. This has sparked heated debate across politicians and industry leaders, with many stating that foreign involvement is necessary to the country’s economic and environmental health.

We are pleased to share our recent conversation with Duncan. We discussed Mexico’s relations with the United States, challenges the Mexican Energy Sector is facing under a new political administration, and the positive and negative implications of Mexico’s energy reform thus far.

ED: With the current state of the US and Mexico relations, and the increasing attention to the border region, how are the US and Mexican administrations working together to meet energy demands for both nations?

DW: We’re in a particularly interesting time. On the general level, bilateral relations are actually quite healthy. But when we come down to look at the energy sector, there is no doubt that the new administration in Mexico has a resource nationalism approach and wants to make Mexico’s energy sector more state-dominated, or more nationalist-oriented.

We see this in the statements that have come forward from the new administration so far, in particular with regards to ceasing imports of light crude from the United States – trying to cut back on the import of gasoline and other refined products. There is a focus on trying to make Mexico independent in energy production. We’re seeing a focus on strengthening Pemex, the national oil company. We’re seeing a reluctance to have any more bidding rounds for oil and gas exploration and production. And we’ve seen declarations from the president, Andrés Manuel López Obrador, that he wants Mexico to become entirely self-sufficient in terms of energy production, including natural gas, which is an extraordinary statement, given the fact that Mexico has such a huge deficit in terms of natural gas production. Mexico has huge natural gas reserves but it would take years to develop them and would probably result in more expensive gas supplies.

I think that these factors are really going to make things quite complicated for bilateral relations in energy. The public line that comes out of the United States is that there are ongoing conversations, that there is ample room for cooperation. But my own prediction is that we’re going to see a falling off of cooperation in the energy sector between the US and Mexico.

ED: What impact do you think that the USMCA and CPTPP will have on Mexico’s energy industry?

DW: The USMCA, if it eventually gets ratified, will provide certain benefits for investors in Mexico, including investor-state dispute settlement, which is important because those protections have disappeared for many other sectors of the economy, but they remain for the energy sector. That’s very important.

Of course, free trade in energy products is protected by the USMCA as well. It was interesting that after the July election, Andrés Manuel López Obrador, as the victorious candidate and as president-elect, instructed his lead negotiator for the NAFTA, Jesus Seade, to agree with everything that former president Peña Nieto’s team had been negotiating, with the exception of one thing: energy.

He wanted to see the language of the energy chapter in the USMCA change so that it didn’t reinforce or confirm the benefits of the 2013 energy reform in Mexico, but instead, just stated that every country has a sovereign right to determine the future of their energy sector.

While that doesn’t really change the reality of energy trade or investment today, it was certainly a sign that the new president-elect would be serious about reclaiming national determination of the oil and gas sector in particular. And we’ve seen that reflected in his statements so far.

In terms of TPP11, again, there are certain provisions to do with investments, but this isn’t really going to have a very big impact on Mexico’s energy sector.

All of the big changes that we’re going to see in 2019, 2020 and 2021 are going to come from the policy direction currently being directed from the Mexican presidency, and the Mexican Federal Government.

ED:  How do you foresee the energy industry being shaped over the next six years under the administration of the new president of Mexico, Andres Manuel Lopez Obrador?

DW: There’s no doubt in my mind that Andres Manuel Lopez Obrador would like to reverse the energy reform of 2013, but he’s been instructed by his advisers that that would be political and economic suicide at this point in time. It would cause such huge destruction in the investment climate in Mexico that it could likely generate either a financial crisis, or a currency crisis.

For the time being, he has committed to leaving the constitutional reform in place. But if you look at what he promised in his campaign manifesto in 2018, he promised that he would enact secondary laws that would change the reality on the ground of Mexico’s energy sector.

So the secondary, or implementing laws – in particular the hydrocarbons law – we expect that to be changed at some point during 2019 or 2020. The government has a pretty full legislative agenda at this point in time, so I’d like to see when it makes it on to the legislative calendar.

However, we are beginning to see a lot of smaller changes which, nonetheless, have a huge impact. For example, we’re seeing a lot of people leaving the regulatory organizations. We’re seeing their budgets basically cut, and there I am talking about the CRE, the energy regulatory commission, and the CNH, the hydrocarbons commission.

We’re seeing statements by the energy minister which are certainly antagonistic to the private sector. Just a couple of weeks ago, she said that she would personally have to sign gasoline import permits from this point on, suggesting that she wants to have control over who can import gasoline into the country. This is protected by the energy reform of 2013, and some important foreign companies in Mexico are importing their own gasoline.

I think we’re seeing the signs there already for much more of a state-oriented, state-dominated focus. And that’s even before we get into what’s happening with Pemex. There’s a clear desire to strengthen Pemex, not just on the E&P side, but certainly also on the refining side. There has been a failure to understand how investors see Pemex. We saw that disastrous trip up to New York where they laid out the plans for Pemex over the next few years, and essentially got laughed out of the room by the investor group. Then we have had unsuccessful attempts to revise the Pemex plan which have been received with very little enthusiasm by markets and investors.

In the meantime, of course, Fitch (the credit rating agency) has downgraded Pemex’s debt by 2 grades to a notch above junk. That was also a very telling moment for the administration because of the way that they reacted to it. We saw that they reacted in not the most positive way. Rocío Nahle, the energy minister came out and said that she didn’t trust Fitch’s calculation, and this is a very highly respected and regarded credit rating agency. But because they gave a negative review of Pemex debt, the energy minister decided not to take it seriously. We have since seen Moody’s and S&P issue similarly pessimistic evaluations that go beyond just Pemex and cast doubt on the future of the Mexican economy in general.

These are, as I said, worrying signs, but they’re pretty clear signs to me that they are moving in a much more nationalistic state-oriented direction.

ED: In your opinion, what are the main challenges the Mexican energy industry is facing, and how can they be overcome?

DW: The government doesn’t seem willing to engage with the energy industry, or offer them the opportunities that the previous administration had given them. And the best example of that, of course, is the electricity generation bidding rounds, and oil exploration and production bidding rounds, which the government has brought to a halt.

That means that investors who were interested in putting their money into Mexico, and willing to engage in possible enterprise in Mexico, now see that their opportunities have been cut off. We also see that companies which have already invested in Mexico have become much more nervous about the future of their investments. We’ve actually seen that the total monthly investment by the private sector in Mexico’s energy sector dropped off last year during the election because of the uncertainty.

The way to overcome this is challenging. It’s very difficult to see how private companies can overcome these obstacles, and that’s simply because it would require a change of heart on the part of the administration.

Now, president Andrés Manuel López Obrador has said on a couple of occasions that he’s willing to consider more bidding rounds if the private sector (those companies who’ve already invested) is willing to increase their total levels of investment and to speed up their investment, then he might be convinced that bidding rounds are a good thing. We have also heard his Chief of Staff, Alfonso Romo, suggest that the bidding rounds may re-start in the next few months. I am skeptical that that will actually happen.

I think the private companies that have already invested in Mexico need to engage more positively with the current administration, but they also need to make sure that they are protecting their corporate interests and recognize that the climate of uncertainty at this juncture is probably not going to go away any time soon. We come back to a classic case of government affairs, government relations, trying to work out exactly in which direction the administration is going, and finding ways in which we can engage in a constructive way.

There is a possible light at the end of the tunnel, and that is that Pemex production is dropping, and the plans that have been presented by the government don’t seem to be able to turn that production around in the short term. That’s going to mean a hit for Pemex in terms of cash flow and for the administration in terms of government revenue.

At the same time, we’re seeing that the administration claims that it doesn’t need to have any more private investment in the electricity sector. In fact we heard the head of the CFE, Manuel Bartlett question why the utility would ever want to buy power when it could generate it itself. But CFE lacks the capital and bandwidth to be able to generate sufficient power and if economic activity continues to grow in Mexico, then there will be a shortage of supply at some point.

When those situations hit, then the Mexican government is either going to have to reevaluate its approach, or it’s going to decide that it’s willing to take the economic hit. At that point, that may well be the opportunity for private companies to say, “We’re still willing to work with you. Just tell us how we can help you get over these problems.”

ED: Which sector or regions in Mexico have already benefited from the energy reform, and what negative implications may now be at stake?

DW: What we’ve seen from the energy reform so far is significant new investment going into exploration of production. It is not as high as the current administration would like to see, but certainly, if it were to continue, then we would begin to see the benefits of this in perhaps four to five years, as first oil begins to come out of these projects.

Secondly, on the retail sector, there’s no doubt in my mind that the Mexican gasoline consumer has benefited, simply by having a much more diverse marketplace. Previously it was just Pemex that was out there, as the only gasoline brand. Now we have a plethora of private companies competing alongside Pemex, even though, with the exception of one or two companies, we’re just looking at the same product being sold, with each company using its own additives.

We are seeing a differentiation in terms of quality of service, and that’s important because it has been a headache for the Mexican motorist for a long time. It was very common that you go to a Pemex gas station, you’d pay for a liter of gasoline, and you wouldn’t get a liter of gasoline put into your car. If you did get a liter of gasoline, it was low quality and was dirty gasoline. Not to mention the lack of payments options and the3 risk of credit card fraud.

What we’re seeing right now is an improvement in service. There’s an improvement in quality, partly because of those additives that are being put in, and this is something that will long term improve the quality of service for Mexican motorists, and hopefully will extend the lives of their vehicles, as well as hopefully having a positive impact on their pocketbooks.

Lastly, I would say, the electricity sector can claim a major victory because of the energy reform, and that is because we’ve seen record low prices being offered for renewable energy production in Mexico. Just the other day we saw that electricity is being generated from renewable sources at world record low prices in Mexico. It is an extraordinary transformation that we’ve seen, and many billions of dollars are going into electricity generation in the country. That has provided a big boost to the renewable energy industry. Unfortunately, it doesn’t seem as though the current administration is interested in continuing that. In fact, they maybe have even taken several steps back by committing themselves to producing electricity from coal, and from fuel – oil even.

We’re watching that very closely, but once again it’s an example of where the proponents of the 2013 reform did a really bad job of communicating to the Mexican public how beneficial the energy reform turned out to be, and also how those benefits are probably not going to be felt for several years to come. And because of that, there is still generally a negative feeling towards the 2013 energy reform, and that, in part, helped to propel Andrés Manuel López Obrador to his victory in July of last year.

ED: What do you foresee as the most controversial topic at the 2019 Mexican Energy Forum?

DW: The most controversial issue will be whether or not Mexico needs foreign and private investment in oil and gas exploration and production, and what kind of investment climate exists in Mexico.

Any representative from the current administration is going to show up and say that Mexico is doing well and doesn’t need private and foreign investment – that goals can be achieved just by focusing on Mexican capacity, and in particular the state itself, Pemex and CFE. And I think that the private investors are going to be saying, “I don’t think you can meet your target. You’re going to need us, but in order for us to invest, you’re going to have to change your attitude. You’re going to have to change some of the things you’ve been doing, particularly on the regulatory front.” Investors are deeply nervous about the sector, and the government needs to find a different strategy if they are to feel reassured.

I think it’s going to be a fascinating conversation that we see developing at the event, and one which is of critical importance in determining the future of the energy sector.

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Energy Dialogues again proudly presents the 2019 Mexican Energy Forum, taking place in Mexico City this June. Already established as a premier event for the Mexican and global energy sector, the MEF offers exclusive strategic dialogue and connection among top industry leaders. Join Duncan Wood and other eminent energy front-runners for panel discussions, speaker presentations, networking opportunities, and commercial benefits.