Latin Oil Proves a Mixed Blessing

MEXICO CITY -- Mexican President Vicente Fox and federal legislators are locked in an unprecedented budget standoff. One reason: the price of oil.

Mexico relies on revenue from its state-owned petroleum company to finance about one-third of federal spending. Record petroleum prices earlier this year had lawmakers feeling flush. Betting that the oil bonanza would continue, they tacked more than $6.5 billion in spending on to Fox’s proposed 2005 budget.

Instead, Mexican crude prices have slid more than 30% since October, along with prospects for a balanced budget next year.

Legislators “are creating artificial money, money that doesn’t exist,” an irritated Fox said this month after Congress refused to lower its oil revenue projections for next year. “Every irresponsible action has a costly consequence for the nation.”

As Mexico’s example illustrates, oil is once again proving a blessing and a curse for Latin America’s petroleum-producing nations.

On the plus side, higher prices helped fuel solid economic growth in the region this year, with oil-dominated economies expanding at a torrid pace. Oil-rich Venezuela’s gross domestic product surged 15.8% in the third quarter compared with the same quarter a year earlier, and fellow petroleum exporter Ecuador saw its economy grow 10% over the same period.

Mexico, the world’s No. 5 oil producer, saw its gross domestic product expand by 4.4% in the third quarter, the fastest clip since 2000.

The trouble, experts say, is that these nations can’t seem to shake their decades-old habit of spending most of the windfall on today’s social programs instead of paying down debt, investing in infrastructure and replenishing their oil sectors to keep the black gold flowing for years to come.

For example, Venezuelan President Hugo Chavez earmarked $1.7 billion of petrodollars for popular literacy and anti-poverty programs before an August referendum in which Venezuelans affirmed his rule.

Chavez has championed the use of oil revenue to invest in the nation’s human capital and to bridge the yawning gap between rich and poor. But critics say he is running the state-owned oil monopoly, Petroleos de Venezuela, into the ground.

Ramon Espinasa, former chief economist for Petroleos de Venezuela and now a consultant at the Inter-American Development Bank, said Petroleos de Venezuela was pumping 1 million fewer barrels of oil daily than it was in the late 1990s. He said the government was sucking so much revenue to pay for social programs that the oil company was being starved of resources needed to expand production.

“They are making a stew out of the goose that lays the golden eggs,” Espinasa said.

Oil wealth is also helping Latin governments put off tough reforms that will be even more painful if crude prices slide, as some expect in 2005. With oil prices flying high earlier this year, Ecuador bowed to pressure by retirees to boost their pensions, postponing a much-needed overhaul of its struggling retirement system.

Proposals by Mexico’s Fox to expand the nation’s small tax base have gone nowhere, in part because higher oil revenue has reduced the pressure to squeeze more tax money out of individuals and businesses.

“I can’t see [Fox] lowering the Mexican government’s revenue dependence on oil” anytime soon, said economist Collin Peng-Sue, a Mexico specialist at Economy.com.

Oil producers such as Mexico are in much better shape to withstand a drop in crude prices than they were a couple of decades ago. Petroleum accounted for nearly 80% of Mexico’s exports in the early 1980s. The government borrowed heavily against its oil wealth to finance a spending spree that ended in disaster when crude prices fell in 1982. Mexico couldn’t pay its foreign debt, and capital fled the country, leading to a currency devaluation and hyperinflation.

Thanks to the North American Free Trade Agreement, Mexico’s economy today is much more diversified, with oil accounting for about 10% of exports. The federal government by law has to share some of its 2004 windfall with Mexico’s states, setting aside more than $1 billion for them as of September. But it also has directed some funds toward improvements in the state oil company and channeled some into a rainy-day fund as well.

Much of Mexico’s oil is a heavy, “sour” crude with a high sulfur content that sells at a discount to light West Texas Intermediate, the benchmark for oil pricing. Average prices for Mexican crude, peaking at just over $42 a barrel in late October versus more than $55 for West Texas Intermediate, slid to $25.70 early this month before settling back to $29.01 on Thursday.

The seesaw market has made Mexico’s budget planners nervous. Fox wants to use a conservative estimate of $23 a barrel for 2005. Opposing legislators have opted for $27, a figure that some analysts say is too aggressive given that global demand is expected to moderate next year.

Investors have shrugged off the flap. Shares on Mexico’s Bolsa, the stock exchange, soared to record highs this month. Some analysts say Mexico has showed admirable spending restraint compared with countries such as Venezuela.

Others disagree. Credit rating firm Fitch Ratings recently chided Mexico for not tucking away more of its petroleum windfall, noting that oil producers such as Russia and Kazakhstan have done better.

An analysis this year by Mexico City economist Rogelio Ramirez de la O shows that Mexico spent most of the increase in oil royalties over the last few years on public-sector salaries and other immediate expenses.

Meanwhile, investment in infrastructure has stagnated, the analysis said. And Mexico has put off tough energy, labor and tax reforms needed for it to stay competitive with China and other booming Asian economies.

“It’s a scandal,” Ramirez de la O said. “Oil is a finite resource that we should be investing, instead of using it to pay this month’s bills.”

He and others say Mexico’s oil woes are far from over as long as the treasury continues to use the state petroleum monopoly, Petroleos Mexicanos, known as Pemex, as its piggy bank. The government funnels about 60% of the oil giant’s revenue into public spending.

Pemex is overstaffed and heavily indebted compared with other oil industry players. Add generous salaries and exploding pension liabilities for the company’s 143,000 employees, and there is little left over to invest in developing reserves.

That is a huge potential problem for Mexico because its largest oil field is already pumping at capacity and proven oil reserves have fallen sharply. Congress rejected a move this year to lower Pemex’s tax bill, which would have freed up more revenue for the company to invest in exploration, extraction and refining.

For now, privatization of Pemex remains anathema to many Mexicans, who consider the nation’s oil a sacred patrimony. But some wonder whether Mexico and others have once again blown a golden opportunity to get the most bang for their oil bucks. “Some countries in the region are spending most of the present boom,” said Guillermo Perry, the World Bank’s chief economist for Latin America and the Caribbean. “They are just spending without spending for the future.”

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Latin presence

Oil producers ranked by average 2003 oil output (in millions of barrels a day)*

*--* Country Production 1 Saudi Arabia 9.9 2 United States 8.8 3 Russia 8.5 4 Iran 3.9 5 Mexico 3.8 6 China 3.4 7 Norway 3.3 8 Canada 3.1 9 United Arab Emirates 2.7 10 Venezuela 2.6 11 Britain 2.4 12 Kuwait 2.3 13 Nigeria 2.2 14 Algeria 1.9 15 Brazil 1.8 16 Libya 1.5 17 Indonesia 1.3 18 Iraq 1.3 19 Kazakhstan 1.0 20 Qatar 1.0 21 Angola 0.9 22 Argentina 0.8 23 Egypt 0.8 24 India 0.8 25 Malaysia 0.8 26 Oman 0.8 27 Australia 0.7 28 Colombia 0.6 29 Syria 0.5 30 Yemen 0.5 31 Ecuador 0.4

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*Includes crude oil and other petroleum liquids

Source: Energy Information Administration