Political Shift May Revive Efforts to Reform Mexico Oil Monopoly

As cash cows go, few match the pedigree of Petroleos Mexicanos. The state-owned oil monopoly provides Mexico’s government with $20 billion, or a third of its annual budget, and its economy with 118,000 well-paying jobs.

But the world’s fifth-largest government-owned petroleum company also is bloated, grossly inefficient and technologically challenged and has been bled dry by the government itself. Years of neglect have left natural gas reserves underdeveloped at a critical time and its refineries in such shoddy shape that crude-rich Mexico must get its gasoline from other countries.

The July 2 election of a new president, Vicente Fox, without political ties to the legions of Mexicans with a vested interest in Pemex, may finally provide the opportunity to open up the company to true competition and more private investment.

The liberalization of Pemex would conform with what economists predict will be Fox’s redoubling of President Ernesto Zedillo’s efforts to privatize federally run services, from electricity to airports.

“Fox people say they want $20 billion a year in foreign direct investment,” said Alfredo Coutino, chief of macroeconomic analysis at Ciemex-WEFA in Philadelphia, who recently met with Fox advisors. “They’re talking about opening up the energy sector and electricity, and they are saying they want to stimulate foreign investment in strategic areas like telecommunications, airports and the port system.”

Liberalization of Mexico’s energy industry won’t happen overnight. A thorough overhaul would require a coalition for reform in the Mexican Congress where Fox’s National Action Party, or PAN, lacks a clear majority.

But more than six decades after President Lazaro Cardenas expelled foreign oil companies and nationalized the industry, a consensus has developed in some government quarters for some degree of commercialization of Pemex, due partly to the globalizing world economy and the rapidly increasing energy needs of the country.

Privatizing Efforts a PAN Priority

“Inviting private investment would free up funds for things like building schools, vaccinating youngsters and improving Mexico’s infrastructure, all critical needs for a nation where half of the population lives in abject poverty,” said George Grayson, a professor at the College of William and Mary in Virginia and an expert on Mexico.

Most Latin American energy monopolies have already seen such reforms, either through outright privatization or lesser steps. The trick in Mexico, observers say, is to privatize Pemex in fact, but not in name.

“Change is absolutely necessary. It’s an anachronism unless it does,” said Luis Giusti, formerly head of the Venezuelan state oil monopoly Petroleos de Venezuela and now senior advisor at the Center for Strategic and International Studies in Washington.

Actually privatizing Pemex, which would require a constitutional amendment, is still regarded as a political impossibility. It remains a rallying point for many Mexicans who chafe at the thought of foreign commercial imperialism. Fox caused an uproar last year when he said he’d consider such a move and has been backpedaling ever since.

But Fox, formerly Mexico’s top Coca-Cola executive, has said he wants to make Pemex behave more like a private company--and the global oil industry is abuzz with speculation on how he might try to reshape it.

He has said he wants to “liberalize” pieces of the Pemex monopoly, possibly opening up refining and certain other operations apart from crude-oil production to permit private investment and allow foreign or other private gas and petrochemical producers to compete on Mexico’s turf.

He might even seek to allow outside gasoline retailers to enter the country, now the sole province of Pemex with its thousands of generously staffed green-and-white service stations.

Because Fox owes nothing to the powerful oil workers union, which supported opponent Francisco Labastida, he may also try to trim Pemex’s bloated payroll, which some say is more than twice what it should be, even after the cutting of 100,000 jobs over the last decade.

A top legislator in Fox’s party said reform of Pemex is high on the PAN’s list of priorities.

“We see Pemex as a very inefficient firm and mired in corruption. It has been a great source of corruption, from purchasing to inventories and even to the sale of crude oil itself,” said Juan Bueno Torio, a leader on energy issues.

Investing in Energy to Protect State Economy

Not that Pemex is in any danger of collapsing or running out of oil.

With its average cost of production as low as $2 a barrel in the Gulf of Mexico, Pemex makes a killing these days selling oil for about $24 a barrel. And among the non-Persian Gulf nations, only Venezuela sells more oil to the United States.

But unless Pemex begins to invest in its oil and gas operations, it runs the risk of losing production and ultimately squandering a resource that has become central to the economy’s health. By some estimates, Mexico needs to invest $30 billion in its energy sector--a sum that the country will need to go outside to raise.

A case in point is Mexico’s failure to develop its rich natural gas fields. The result is that Mexico is unable to meet the growing demand for natural gas, caused partially by the fast-growing economy and also by the conversion of most of its electricity-generating plants to clean-burning gas from fuel oil.

“Gas production in the country has virtually stagnated. You have to produce it in a much more aggressive way if you pretend to switch to electricity in a cost-efficient way,” said Eduardo Lopez, an analyst with Petroleum Finance Co. in Washington. “Relying on imports is a very bad bet because natural gas prices are rising fast.”

Mexico has opened up natural gas distribution to outsiders, but companies complain about being forced to buy gas only from Pemex before reselling it and say the market opening must go further.

Energy Secretary Luis Tellez, who under President Ernesto Zedillo has had mixed success pushing for reforms to make the petroleum and electricity industries more competitive, agrees that big changes are needed.

“I frankly believe that in Mexico we have an energy sector that is not at the level of what is happening in the world, though not for lack of political will by the president,” Tellez said in an interview in the newspaper Reforma after the election.

Zedillo’s proposal to essentially privatize the electricity industry was shelved in the face of stiff opposition, even within his own party. And a reform allowing private companies to become minority investors with up to 49% ownership in the state-owned petrochemical industry withered; foreign investors wanted control of the companies.

Bueno Torio, the PAN’s congressional leader for energy issues, said Fox’s proposed socioeconomic pact with the major political players in Mexico will include energy as a key theme.

“We don’t want to privatize anything that is today part of the national infrastructure. But we are thinking of modifying the law to permit private industries to invest in electric energy as well as petrochemicals and gas, so that private investment can participate in the development of the infrastructure the country needs to grow at 7%,” Bueno Torio said.

Many believe that what Pemex needs most is reform of the tax laws that enable the government to bleed the company of money to the point that some insiders fear its financial foundation is at risk.

Indeed, last year the government took all of Pemex’s operating profit, robbing the company of its ability to invest in maintenance and developing future assets.

Others say the company must change its corporate structure to make it look and act more like a real company--and to shield it from the greedy hands of the government. Its 11-member board is made up of six government ministers and five union officials--not exactly a fount of industry expertise.

“Pemex requires serious management reform to channel new resources. Just letting in foreign investment won’t do it. And it involves more than getting rid of probably half the employees, but changing the structure, the way the company is run. If not, all that extra investment could be wasted,” said Petroleum Finance’s Lopez.

Another step urged on Pemex is making some of its own investments overseas, as other oil-exporting nations have done. Venezuela owns the Citgo chain of gas stations in the United States, and Saudi Arabia owns Texaco retail outlets.

Pemex does own a 50% interest with Shell in a refinery near Houston, but should be more aggressive about ensuring an end market for its refined crude in the world’s largest energy market, said Giusti of the Center for Strategic and International Studies.

Bringing Competition to the Marketplace

But the overriding priority is to introduce some competition in Mexico where market control by the Pemex monopoly is hurting consumers most, said William and Mary professor Grayson. Making Pemex compete against a Texaco or Exxon in jet fuel or gasoline markets, or against an El Paso Energy for natural gas sales would mean lower energy prices for consumers and industry alike, he said.

“There was once cause for worry that foreign investors in the oil industry would run off with profits or exert unwanted political influence,” Grayson said. “But in a globalized economy where 83% of Mexico’s exports go to the United States anyway, Mexico should use its assets in the most productive way possible.”

But Miguel Garcia Reyes, a professor at the Colegio de Mexico who studies the oil industry, said the Fox administration still has to sell the Mexican public on the necessity of liberalizing Pemex.

“I believe this opening up to foreign capital is inevitable, but the problem is they haven’t shown political sensitivity, which has made it much more difficult,” Garcia Reyes said. “So far [the government] hasn’t convinced the people of the advantages of opening the sector to private capital. Instead they have tried to impose it.”

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Crude Comparison

The inefficiencies plaguing Pemex, the Mexican national oil company, are illustrated by a comparison with Petroleos de Venezuela (PDVSA), the Venezuelan state oil monopoly. The two monopolies produced comparable amounts of crude oil in 1999, but Pemex had much higher administrative costs. Pemex also has a bloated work force, only partly explained by its larger retailing and petrochemical operations.

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Average daily liquid hydocarbon production (In millions of barrels)

Pemex: 3.343

PDVSA: 3.560

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Administrative costs (In billions of U.S. dollars)

Pemex: $1.93

PDVSA: $1.19

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Administrative costs per barrel (In U.S. dollars)

Pemex: $1.58

PDVSA: $0.92

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Employment

Pemex: 118,000

PDVSA: 42,000

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Sources: The companies