In 2012, the Harvard Business School published a case study titled “Pemex: In a Free Fall?” that analyzed the challenges facing Mexico’s state oil company in 2009, when J.J. Suárez Coppel took the helm as CEO. Many of the issues outlined in the study remain a problem today: production and reserves in decline; high taxes resulting in after-tax losses; high levels of debt; not enough money for capital expenditure in exploration and production; too much concentration on large shallow-water fields; too many employees and a union that makes it hard to restructure; compressed wage scales; and legal limits that only allowed the company to sign service contracts with outside partners, leaving it unable to share risk.
Ten years later, the situation is similar, but worse in almost every respect. Current crude production is at 1.67 million barrels per day, almost 40% lower than a decade ago. Proven oil reserves are currently 7.7 billion barrels versus 11.9 billion in 2009, a 35% decline. And Pemex is the most indebted oil company in the world, with $106 billion in financial debt, and pensions and other liabilities worth another $70 billion. Despite some advances, including a 15% reduction in a still-bloated payroll, the company is facing a more dire outlook than it was 10 years ago.
Yet there is one crucial difference: a decade ago, constitutional restraints meant that the obvious solutions to Pemex’s ills – partnering with international oil companies, selling non-core assets, reducing its tax burden, and obtaining some financial and operational autonomy – were still legally out of reach.
Today, thanks to reforms enacted under former President Enrique Peña Nieto that opened Mexico’s oil sector and allowed Pemex more room to maneuver, the roadmap to the company’s recovery is clear. Pemex needs to concentrate its investments up-stream, were the profits are. It should be the sole operator in the lower risk and higher profit areas that it manages well. It should partner with private companies to undertake risky exploration with limited downside exposure, develop deep-water fields and incorporate technology and know-how in the development of shale resources. Non-core assets should be sold or transferred to other state entities. In the future, a minority of Pemex equity could be listed on the market, though that would require further legal changes and may be politically inviable.
None of these ideas hold much mystery. The problem lies in President Andrés Manuel López Obrador’s desire to look to the past for solutions, rather than those that are right in front of him.
For decades, Pemex has been the largest contributor to the government’s budget. It is one of the oldest national oil firms and, despite its recent decline, still one of the 10 largest in the world. Due to the large rents generated by oil extraction, national companies rarely lose money before taxes. Pemex remains a source of pride for politicians and the public, and will thus likely remain the leading player in the Mexican oil sector for the foreseeable future, come what may.
But López Obrador has essentially turned his back on his predecessor’s energy reform. He announced Pemex would stop the planned sale of non-performing assets and its ambitious plans for risk-sharing with private partners through joint ventures known as farmouts. In its place, the administration has announced a tax cut for Pemex estimated to reduce the company’s tax burden by $7.1 billion over the next two years, and a capital infusion from the government for an additional $7.4 billion. The administration also said it would pursue service contracts, similar to those implemented a decade ago, which have had minimal effect on investment and production.
In addition, Pemex will refocus on shallow-water fields and will build a new $8-billion refinery. The refinery decision is particularly controversial, since Pemex has incurred significant losses in refining, and buying the same refining capacity in Texas would cost a fraction of the planned investment. Overall, the new policies are unlikely to reverse Mexico’s production decline and would most likely lead the company to be less profitable, unless the price of oil comes to the rescue. In fact, investment was significantly increased in 2009-2013, but it failed to reverse the decline; investing in a new refinery is almost surely a money-losing proposition.
There are now two powerful forces blocking meaningful reform under the current administration: ideology and politics.
For a long time Pemex lived off its considerable geological luck. In the 1970s, just when the price of oil boomed, the company discovered massive offshore fields in shallow waters. As a result, crude production multiplied by more than six. Cantarell, the most productive of those fields, peaked at 2.1 million barrels per day in 2004, a level higher than most OPEC producers. High rents and low lifting costs meant that for three decades the Mexican government could significantly over-tax Pemex, collect low taxes from the rest of the economy, subsidize refining, use the company as a social development tool, and still maintain (or even increase) production, with little investment. When production started to collapse in 2004, the oil price boomed, so the company still did not feel the pain immediately, delaying the reform push. Combine memories of the past and a tradition of resource nationalism that has been an integral part of the country’s ideology since the Mexican Revolution, and López Obrador believes, along with a significant part of the Mexican public, that the good times can come rolling back.
But all that is improbable. Mexico has plenty of geological potential, but most of it is in the high-risk deep-water or in the low-margin unconventional plays. It may take a while, but economic realities will sink in, and hopefully oil policy would become more pragmatic. But if the memory of Pemex’s past glories makes López Obrador unwilling to enact real change, the company could be in for a bumpy ride.
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Francisco Monaldi is Fellow in Latin American Energy Policy and Director of the Latin American Initiative, Baker Institute for Public Policy, Rice University.
