Can America Save AMLO’s Energy Policy From Himself?

The Biden Administration is considering trade action against Mexico because of its nationalistic energy policy. In point of fact, under NAFTAFTA
, energy was excluded from free trade actions because of recognition that oil was such a sensitive subject for Mexico that it would have blocked the entire deal. However, Mexico began reforming its energy sector under one of Andrés Manuel López Obrador (AMLO)’s predecessor, Enrique Pena Nieto, and it was relatively successful, with new oil discoveries and a spate of renewable energy projects.

But AMLO, upon achieving power, argued for undoing the reforms claiming, among other things, that the reforms had created the well-established mess at Pemex. In reality, not only did that mess predate the reforms, but the mess was the result of just the type of political interference that AMLO was embracing.

The company had been used as a piggy-bank for the government, forcing it to borrow tens of billions of dollars to cover its operations. The labor union, with its ties to the long-ruling Institutional Revolutionary Party (PRI), had excessive power over personnel decisions leading to feather-bedding while politicians often rewarded allies with contracts. Mexican oil production had been in a long-term slump and it has been importing natural gas—and sometimes gasoline—from the U.S. as the figure shows.

Of course, importing gasoline is not necessarily unwise, since the refinery industry usually operates with very thin (even negative) margins, so that it is often cheaper to import gasoline than build a new refinery. Unfortunately, AMLO made building a new refinery one of his flagship projects, with a price tag that has now reached $12 billion and may go higher, as Pemex struggles to meet the President’s unrealistic deadline.

The situation is even more absurd than this, with the country’s existing refineries operating at less than 50% of capacity, an abysmal record the result of years of underfunding the sector. Lacking detailed inside knowledge about the company, it is nonetheless a rule of thumb that repairing/rejuvenating existing capacity costs much less than building a greenfield facility. Which merely affirms that the new refinery, being built in the President’s home state of Tabasco (shocking, I know), is merely a prestige project, not one that makes economic sense.

Like many politicians, AMLO seems impervious to reality, embracing a 1960s leftist ideology that demonizes the private sector. In this, he is emulating such economic thinkers as Hugo Chavez and Fidel Csstro—except their thinking has resulted in abysmal economic performance. The greatest economic petroleum development in Latin America in the past three decades was the Venezuela reform, which saw private investment and oil production surge during the 1990s.

This was remarkable for two things: Venezuela had long been derided as a mature oil province; the consensus was its production would decline over the long term. The figure below shows the EIA’s high and low assumptions of production capacity for Venezuela at different times, and they expected it to drift down, in line with the consensus among (most) forecasters that only the Persian Gulf producers had the ability to expand supply.

The other salient fact is the nature of the production increase. Although attention was generally focused on the heavy oil/Orinoco projects developed with foreign oil companies, approximately 600 tb/d of production was added in so-called ‘marginal fields.’ These were aging fields where production had dropped over time, and the reforms allowed private firms to bid on a field and redevelop it with more drilling and enhanced recovery. Almost certainly, the same could be done in Mexico and bolster the country’s supply at no cost to the government and indeed, providing them with new tax revenue.

It would be so nice if AMLO would take advantage of the U.S. trade action to do what many other leaders have done: use foreign pressure to take unpopular steps that will yield long-term benefits. Under his predecessor’s petroleum reforms, Mexico had a change to emulate the success of the Venezuelan apertura, but instead, he wants to cling to his ideological beliefs and go down the same path as Hugo Chavez and Nicolas Maduro, to his nation’s detriment.

Instead, perhaps AMLO should take the path followed by former, and perhaps future, Brazilian president Luiz Inacio Lula da Silva, popularly known as Lula. He promoted social welfare spending, relying on the private sector to generate funding for it with pro-growth economic policies. The government—and politicians—made the difficult decision to sacrifice complete control over the oil sector in return for greater production and revenue to pursue their laudable goal of improving the welfare of the poorest.