Mexico’s proposed energy reforms enthuse bankers
Sector opened to private participation; expected to add 1.5 points to annual GDP growth.
Mexico’s president, Peña Nieto, announced his proposal for energy reform in August and despite initial disappointment in the markets – Mexico’s stock market fell more than one percentage point after his speech – the consensus is that the reform is positive for the Mexican economy and will lead to 1.5 percentage points of growth in the medium term. The main elements of the proposed reform allow private-sector participation in the oil and gas industry through profit-sharing agreements for exploration and exploitation, and through permits for refining, petrochemicals, transport and storage. Pemex’s fiscal regime will also be reformed; currently about 80% of Pemex’s revenues go the government, which relies on the oil company for a little more than 35% of its public revenues.
“I do believe this is the most important of the reforms in terms of growth,” says Marco Oviedo, chief economist at Barclays in Mexico City. “We have already seen some important reforms – like the labour and telecommunications reform – but this one will definitely change the legal framework and open the energy industries to the private sector. What was announced [on August 12] was a starting point and it was very clever of the government to go back to the wording that was published in the 1940 constitution, which doesn’t allow concessions. The oil will remain the property of the state, but the proposal allows the state to have profit-sharing contracts with the private sector to boost production. These contracts can be applied to exploration, production, refining, distribution and retailing.” The primary reforms require a two-thirds majority in congress, and Oviedo argues it breaks the taboo in Mexico about talking about the constitution. However, not everyone was convinced. Credit Suisse published a client note entitled “Well short of what the country needs”, which argued that: “The PRD is against changing key articles in the constitution to allow greater private-sector privatization in the energy sector ... Instead it seeks to change 12 existing secondary laws.”
However, Oviedo believes changes to the secondary laws will be critical, and likely effective. “I think it’s a very important advance,” he says. “The secondary laws will establish the precise terms by which the state can have these contracts with the private sector, and anything can fall within the scope of the secondary laws. I don’t think people have digested the announcement well – everything now comes in the secondary laws – expected in early 2014 – and that is key. I estimated that if you allow the private sector to get more involved and you observe an increase in investment of at least 50% – which is a very conservative level – growth could be boosted by 1.5 percentage points of GDP in the medium term. So if the economy should be growing at 3.5% then with the reforms it could reach 5%.”
Jorge Arce, chief country officer at Deutsche Bank Mexico, expects the energy reforms to have wider benefits for Mexican industry, which will become one the lowest-cost producers of energy in the world. “The geology of this country is amazing. It has huge reserves of oil and gas in the Gulf of Mexico and getting the gas is really just a question of developing the infrastructure,” he says. “With private investment in the energy sector, Mexico can gain – for the first time – competitive advantage in high-energy manufacturing, such as steel mills and smelters. If you talk to CEOs at energy and infrastructure companies they all say this is the best reform we could have had in the first stage. Even the most capitalist Mexicans feel that the oil should be for all Mexicans and this had to be credible.”
Alejandro Valenzuela, CEO of Banorte-Ixe, agrees that the energy reform – if implemented – would be an important development for the country. “We are going to see important levels of investment and Mexico will be a full market economy,” he says. “Chile and Mexico will be in a league of their own [in the region], which sends a huge message about the country.” The government announced that Pemex would have a different fiscal treatment, more in line with how a private firm is treated, which many in Mexico have read as signalling that Pemex will be subject to income taxes. Currently Pemex contributes slightly less than 40% of public revenues and if the intention is to reduce the tax burden of the company, the government will have to find those resources somewhere else.
Rodrigo Brand, economist at Santander in Mexico, says the government is being guarded about its tax-reform proposals, but it has options to increase revenues through extending value-added tax to medicine and food, as well as potentially increasing the VAT rate, currently 16%. However, he believes the outlook is positive. “Energy and fiscal reforms will have an effect on the financial system,” says Brand, who agrees that the reforms might be worth up to 1.5% of extra GDP growth within five years. “There is a lot of room to create an internal driver of consumption within Mexico,” he says.