Some Thoughts on Oil and the Mexican Elections of 2000

For quite some time now, the topic of the possible evolution of the Mexican oil industry has been approached in international oil circles solely in terms of one question: what will it take for Mexico to open its upstream sector to the participation of private foreign capital? Of late, and particularly after Mexico’s entry into the North American Free Trade Agreement (NAFTA), this question has been broached more and more often, in a tone of increasing exasperation at what is seen as Mexico’s intransigence. This has been due to a number of reasons. Firstly, one can mention the collapse of the USSR and of the Soviet oil industry as well. Secondly, radical changes in the petroleum regimes of some other key producers have left Mexico with one of the most restrictive petroleum regimes in the world. The successor states of the USSR, for instance, now welcome across-the-board foreign investment in their respective oil sectors, as do nearly all states which are still nominally committed to the collective ownership of the means of production (like China, Vietnam, Cuba and even North Korea). Iran, Venezuela, Qater and Algeria have now joined the ranks of those OPEC countries which had always permitted equity participation in the upstream (i.e. UAE, Nigeria, Indonesia, and Libya), and both Kuwait and Iraq are set to follow suit in the near future. Thirdly, recent Mexican governments have embraced the neo-liberal gospel with great enthusiasm, and most of the policymakers responsible for economic issues clearly believe, in their heart of hearts, that Mexico would be better off without a state monopoly in oil. In public, these same officials have pronounced themselves against the privatisation of the Mexican petroleum sector, but in moments of candour many of them let it be known that their defense of PEMEX is very much in spite of their personal opinions regarding the virtues of laissez faire. Consider the following words, contained in an interview which a senior official at the Energy ministry gave to one of the oil wire services relatively recently, on condition of strict anonymity: “We´d love to just [sic.] get rid of PEMEX . . . we´d love to keep chipping away at the corners. But we don´t. [Instead] we´re the preservers of the golden past – in the energy sector, (we are) one of the most closed countries in the world” (Timna Tanners, “Mexico may relax grip on Pemex to end cash woes”, Reuters, December 9, 1998).

Such a stance seems to imply that the restrictions contained in Article 27 and 28 of the Mexican Constitution have little practical or economic relevance, and that their retention is partly a reflection of deeply-held (albeit misguided) popular convictions that are a product of the country´s troubled past but also of the fact that the party that has ruled Mexico from 1929 onwards was finding it hard enough to stay in power without alienating one of its key constituencies (namely, the Oil Workers’ Union). Now, of course, the notion that the boat must not be rocked has become meaningless because, come next December, the PRI’s world record of continuous years as a ruling party will definitely stop at 71. Moreover, the victor of the 2000 federal elections is a man who once said that his first act in office would be to sell off PEMEX, and who was elected to the highest office mainly because he is perceived as not being beholden to the entrenched interests that made past PRI governments so ineffectual and, ultimately, disastrous for Mexico. In light of this, is it any wonder that the major multinational oil companies, the governments of the developed countries of the world, and international institutions like the World Bank and the IMF are – discreetly – rejoicing in anticipation at a possible about-face in the direction that Mexican oil policy has followed since 1938?

This, of course, is not surprising at all. What is surprising is the poverty of the debate surrounding this issue. Consider that Mexico stands to lose a lot if oil liberalisation initiatives were to fail to perform as advertised, and also that the Mexican economic landscape is dotted with firms whose privatisation served to perpetuate some of the worst characteristics usually associated with state ownership. Now, there are those who think that this lack of debate is only right, because what Mexico demands is urgent action and not words. As Othón Ruiz Montemayor, Director General of Mexican banking group Banorte, puts it, drastic reforms in the oil sector can no longer be put off because “we have to give this country stable and sustained economic growth. To do this, we have to free up our grandparents´ inheritance” [ibid.]. The economic enfranchisement of the large part of the Mexican population that has been left out in the cold by decades of trickle down economics is a commendable goal, of course, but one is left with the impression that not many people have given a thought to what freeing up their grandparents’ inheritance might mean and entail. What little has been said on the matter, from both sides of the political spectrum, has been couched in terms that are both emotive and equivocal, long on words like “sovereignty” or “efficiency”, and rather short on what exactly will be the hard currency implications of choosing one given policy alternative over another. There is a definite danger that the framing of the liberalisation question in loaded terms like sovereignty and efficiency of will lead to both policy makers and Mexican public opinion losing track of the truly relevant elements around which any sensible debate necessarily has to revolve. These elements are:

1) The conditions for petroleum production in Mexico are extraordinarily favourable, more so than in almost any other region outside the Middle East. During the 1970s, for instance, only three supergiant fields were discovered in the world, and all three were located in Mexico. The supergiants that have been discovered later in other parts of the world have had a lower productivity than the Mexican ones, and most of them have been in remote places which pose considerable logistical problems (i.e. Tenghiz). Mexican oil terminals are three sailing days away from the USA, the largest petroleum market in the world. Finally, as a result of a central geographical position, Mexican oil exports can compete effectively in both the Pacific and the Atlantic basins.

2) Because of these favourable conditions, Mexican oilfields generate huge economic rents. Therefore, the cornerstone of any oil liberalisation policy has to be a hydrocarbons taxation scheme. The question of the property of, and sovereignty on, subsoil resources is totally irrelevant if it is not approached in fiscal terms. Ownership of the subsoil will continue to be vested in the Nation even after privatisation or liberalisation, since no one envisages the introduction of a regime of land and subsoil tenure on the United States model. Policymakers should not forget also that officials and politicians in other countries have sometimes been misled into signing away the family silver while maintaining the trappings of sovereignty, but nothing more.

3) Oil fiscal income in hand is a more tangible form of wealth to projected revenue increases derived from the adoption of more flexible and “neutral” fiscal regimes aimed at maximising production volumes. The experience of some countries demonstrates that these revenue increases have a tendency not to materialise for two reasons: less restrictive fiscal regimes permit increases in costs that are deductible for income tax purposes, on the one hand, and the adoption of production policies predicated on maximizing market share by major oil exporters is very damaging to the international price of oil.

4) The design of a fiscal regime for hydrocarbons activities should take its inspiration from US practice, rather than looking at the example set by the British North Sea. The US system, based as it is on the investment-insensitive royalty mechanism, is far better at meeting the fiscal desiderata of an oil exporting country, whose degree of risk aversion will be very different from that of oil companies, for example.

5) Governments of oil producing countries such as Mexico are in the oil business as much as any oil company, but in a different way. Hence, caution should be exercised when these countries try to apply to their national oil companies the criteria that are normally used to evaluate the performance of oil companies. For instance, no one can dispute that PEMEX appears to be a very inefficient company when compared to the international oil majors on any number of criteria (oil production per employee, say). Yet PEMEX bears a far heavier fiscal burden than any private oil company (indeed, PEMEX is the oil company that pays the most taxes, proportionally speaking, in the world). The crucial point in this regard is that although great amounts of money are dissipated by the inefficiency of PEMEX’s operations, these are far smaller than the ones which the Mexican government would stand to lose if it introduced a flexible and investor-friendly fiscal regime for private oil companies. In any case, one should bear in mind that PEMEX’s efficiency may actually improve as it has done quite significantly over the past 15 years. In contrast, it is impossible to conceive that the Mexican government will ever be able to get any private oil company to bear a fiscal burden that is even remotely comparable to the one PEMEX has had to live with during the last quarter of a century.

Can Mexico really afford to let an instinctive distaste for state-ownership dictate the fate of an industry that provides the government with more than a third of its fiscal revenues? The answer, surely, is no. After all, as Sir Randolph Routh (General Commissioner in Ireland) wrote to C.E. Trevelyan (who was in charge of His Majesty’s Treasury at the time of the Irish potato famine), “you cannot answer the cry a of want with a quotation from political economy”. The question of the liberalisation or privatisation of the Mexican oil industry should not be seen as one involving a false choice between left or right, or modern (private) versus retrograde (state owned). Rather, it has to be approached in terms of what policy options offer the best means of maximising the value of a scarce natural resource whose ownership (even after privatisation) will always be vested in the Mexican Nation, a Nation which certainly cannot afford to get this question wrong. One can always hope that Mr. Fox and his advisors will have a change of heart once he is in office and they are at the sharp end of the Federal budget. However, there is no assurance that ideology will not defeat arithmetic, and recent precedents, both in Mexico and abroad, are not encouraging. Recall, for instance, the enthusiasm with which the Venezuelan government embraced the idea of dramatically expanding oil production in the full knowledge that such a policy would lead to much lower oil prices and, more importantly, a much lower fiscal income.

Given the poverty of the Mexican privatisation record to date, it is perhaps fitting to conclude these reflections with words of caution proffered by a man whose writings and ideas are often misappropriated by the champions of neo-liberalism. Edmund Burke, in his Reflections on the Revolution in France (1796) wrote:

Is it in destroying and pulling down that skill is displayed? The shallowest understanding, the rudest hand, is more than equal to the task . . . At once to preserve and reform is quite another thing. When the useful parts of an old establishment are kept, and what is superadded is to be fitted to what is retained, a vigorous mind, steady persevering attention, various powers of comparison and combination, and the resources of an understanding fruitful in expedients are to be exercised . . . If circumspection and caution are a part of wisdom, when we work upon inanimate matter, surely they become part of duty too, when the subject of our demolition and construction is not brick and timber, but sentient beings, by the sudden alteration of whose state, condition and habits, multitudes may be rendered miserable . . .

By: Juan Carlos Boué