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Mexican play still a guessing game

Mexico’s energy sector and IOCs are waiting to see if the new president follows through with his anti-reform election rhetoric

On 1 December, Andrés Manuel López Obrador will take office for a six-year term as president of Mexico. After a protracted but one-sided campaign, he won a decisive victory in the 1 July polls at the head of the Morena party, which he founded, taking 53% of the vote.

It's the culmination of a lifetime spent seeking Mexico's most senior office. He previously contested the presidency in 2006 and 2012.

López Obrador's credentials are those of a nationalist, leftist outsider. He's also a dogged opponent of the two parties which have ruled since the return to democracy in 2000, the Institutional Revolutionary Party (known by its Spanish acronym of PRI) and the pro-business National Action Party or PAN.

He is anti-corruption, which is a widespread problem for Mexico where the federal government's writ doesn't run to all corners of the country. He is also, at least rhetorically, concerned for the poor. No one doubts his abilities as a campaigner. But in governing will we see a populist or a pragmatist? Will Mexico continue on its path as a conventionally minded reformist state or pursue the wilder ways of Bolivarian leftism?

Energy reform was a major point of contention in the election campaign. In January 2017, as part of a liberalisation package, the outgoing administration of Enrique Peña Nieto raised gasoline prices, predictably stoking popular resentment. Theft from and sabotage of the national distribution system are widespread.

Earlier, in 2013, Peña Nieto's PRI amended the constitution to allow for foreign investment in upstream exploration and downstream oil and gas distribution, ending the monopoly of Pemex, the state-owned oil and gas operator. Since 2015, more than 100 contracts have been awarded to 73 companies including ExxonMobil, Total, Chevron, Shell and Cnooc.

López Obrador was careful over the course of the campaign in his choice of words. He said, for example, that rather than freezing gasoline prices, he wouldn't increase them by any more than the rate of inflation. He can't afford to be too cavalier. Tax revenues from gasoline are a major stream of revenue for the government.

Focus on refining

The president-elect and his team probably have one target in mind: seeking to minimise imports of refined product from the US, with which Mexico runs a sizeable product deficit. Mexico's six refineries are ailing due to lack of investment and government rent-seeking. On 27 July, López Obrador announced that a seventh refinery would be built in his home state of Tabasco at a cost of 160bn pesos ($8.5bn) and that the existing facilities would be upgraded (49bn pesos).

Analysts say that the announcement was at best optimistic, given Pemex's heavily indebted balance sheet. Better, they say, would be to concentrate on upgrading refineries, notably the Tula facility.

"It's the best short-term option. It's fast, easy and simple," says Ixchel Castro of analyst Wood Mackenzie. She also points to opening up access to the pipeline network and debottlenecking measures in a large country with a disparate energy infrastructure.

Optimists highlight the change of policy since the vote over Mexico City's new international airport. López Obrador had threatened court injunctions to halt the airport construction on the apparent grounds of private sector involvement. But, following a planning meeting in early July, an aide indicated that work on the $13bn airport would continue.

"The president-elect has proven that he can take advice …. We have seen this dialogue where he will listen to experts," says Castro.

Anti-reformers picked

López Obrador has the reputation of not being personally corrupt. A previous stint as mayor of Mexico City saw him adopt a more pragmatic stance than his campaign rhetoric suggested. He's also seen as having a simple outlook on finance—that the books should be balanced. Critics note that the governing of Mexico City was underwritten by the federal state. The presidency is altogether a different issue.

More pessimistic observers point to the choice of Rocio Nahle as minister of energy, and Octavio Romero as director of Pemex. Romero is a long-time close collaborator of López Obrador and has been a staunch opponent of the energy reform. Nahle has a degree in chemical engineering and specialised in petrochemicals, but has been "a relentless opponent" of the energy reform, according to Emerging Markets Political Risk Analysis (Empra), a Mexico City consultancy.

"The appointments are a big problem. These are disappointments," says Alejandro Schtulmann of Empra. "The proposed minister of energy is not only a radical but, at one point during the campaign, she asked who is benefiting or profiting from these contracts? It begs the question of how much she understands about the architecture of these reforms. This is worrying."

IOCs boost upstream

Many of Mexico's upstream assets are ageing and in need of enhanced recovery and reservoir management skills which Pemex lacks. In general, the country is under-explored.

Production and declared reserves are declining because discoveries aren't keeping pace with levels of production and growing demand. The National Hydrocarbons Commission said in March that proven oil reserves had fallen fell by 7.4% at the start of 2018 year-on-year to a lowly 8.483bn barrels of oil equivalent. Mexico hit peak oil output in 2014, producing about 3.4m barrels a day. Pemex, which is still responsible for nearly all of Mexico's current crude production, expects to end 2018 with average output of only 1.9m b/d.

Production at the supergiant Cantarell Field, the discovery of which marked Mexico's arrival as a serious hydrocarbon player, fell from 2.2m b/d in December 2003 to 165,000 b/d in February.

But the Peña Nieto reforms have had a galvanising effect. US production expertise is easily extensible into the southern Gulf of Mexico. In July 2017, a consortium led by the US-based Talos made a major discovery in shallow water off the coast of Tabasco, amounting to 1.4bn to 2bn barrels of oil—a quick quarter of Mexico's 3P reserves. Eni has also added substantially to reserves in the Amoca field.

López Obrador may be aware of this. He stated throughout the campaign that he will only "review" the granting of contracts and suspend new contracts. This leaves substantial wiggle room.

The problems are in the differing stances in his entourage. Carlos Urzua, finance minister-elect and an academic, has said the new government won't seek to reverse reforms. According to The New York Times in April, year-to-date the Mexico government had earned $525m from signing bonuses with international investors in oil and gas.

Events in Mexico have a habit of derailing the best of intentions. The country, wracked by the drug trade, suffers extensive violence. The previous administration of the hapless Peña Nieto was holed under the waterline by the gruesome massacre in Guerrero state in September 2014. His position was further undermined by disclosures that he and his wife had benefited from a contractor's favourable pricing on a large new house.

López Obrador has better political antennae than his predecessors. He can campaign on other issues in Mexico such as judicial reform and education. Whether he does so remain to be seen.

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