09/09/2013 12:43 pm ET Updated Nov 09, 2013

Energy Reform and Its Discontents

The congressional debate on Enrique Peña Nieto's recently proposed energy reform has not yet begun, but the battle lines have already been drawn between two groups with fundamentally different views on Mexico's path to prosperity. Proponents of the reform have long stood against what is perceived as one of the country's most longstanding taboos: private investment in any shape or form in the energy sector. Those who oppose it, which include most of the Mexican left, have traditionally held the upper hand in terms of political/moral clout but now face an uphill struggle in preventing one of the world's most restrictive energy regimes from opening up.

Although the reform is likely to pass in some form or another, what is truly guaranteed is that its debate will be anything but sensible and that the reform's passage anything but smooth. Oil is, after all, deeply rooted at the heart of Mexican post-revolutionary identity, to a degree that most foreigners fail to fully comprehend. It is to Mexicans what gun ownership is to their neighbors to the north: a politicized issue that simply cannot be discussed without appealing to a zealous interpretation of history, and without championing an ideologically-tainted view of the country's future.

A clash of arguments

For the proponents of reform, its necessity is driven by a simple logic: 1) Mexico is running out of oil from its traditional reserves. 2) Pemex does not have the technological capacity to exploit its abundant deep-water reserves. 3) A reform is needed to open the sector to private investment so that Pemex can obtain this technology through partnerships and thereby develop into a world-class firm. 4) This reform needs to be approved now, before the dwindling of Mexico's reserves turns the country into a net oil importer in as little as a decade's time. In contrast, the reform's opponents believe that any opening of the market is simply an excuse to let private (mostly foreign) oil firms profit from Mexico's most abundant natural resource. Pemex, it is argued, is in reality a successful and productive firm but which has been turned into a cash cow by successive governments over the past few decades. This situation has resulted in the company's profits being used to service the federal government's budget while it receives preciously little in return, thus making it unable to invest in the technology it needs to become competitive.

Unfortunately, behind these two arguments lie important and deliberate simplifications, contradictions and appeals to emotion -- ¡el petroleo es nuestro! ("the oil is ours!") is one of Mexico's most passionate post-revolutionary battle cries, and we'll undoubtedly be hearing it a lot once Andrés Manuel Lopez Obrador (who else?) mobilizes his masses against the reform beginning this Sunday. But if there is one position that both sides can agree on, it is that Pemex's role as financier for the federal budget is wasteful and unsustainable. Today, Pemex contributes around one-third of the federal budget through taxes; this amounts to well over 4% of GDP. Rather than use a share of its profits for re-investment, Pemex receives whatever the government wishes to give back for its own use -- a pittance compared to what it gives up.

The best energy reform is a fiscal reform

The only realistic way in which Pemex can truly develop into a world-class energy company, therefore, is to free it from its budgetary obligations by providing it with operational autonomy, a new fiscal regime, and have it compensate its share of the budget through more effective taxation elsewhere. In other words, it needs a truly comprehensive and ambitious fiscal reform, one which gives no ground at all to watered-down compromises. The government is well aware of this fact, and has explicitly made mention of tying in fiscal reform in its energy proposal. Unfortunately, whether the fiscal reform will free enough resources to free Pemex from its burden is unclear. The reform will seek to target 3 percent of GDP in extra revenue by 2018, but with plenty of other commitments still pending (such as universal social security) this may not be enough.

Ultimately, however, the way in Pemex is to be turned into a globally competitive firm has not been made clear. Even if one assumes that the fiscal reform will free the necessary resources, it will be a long and costly road ahead for Pemex to make up for decades of underinvestment since -- contrary to claims from the left -- it is far from being an efficient and profitable firm. Its profitability is compared favorably to those of other world-class firms only by conveniently ignoring that they engage in more costly activities (such deep-water drilling) and achieve their profits with a far smaller workforce that Pemex employs. The picture looks even worse if one includes Pemex's massive off-book pension liabilities. As it is, Pemex simply reaps the benefits from easy-to-exploit fields like Cantarell (what's left of it) and Ku-Maloob-Zaap, the latter which has allowed Pemex to stabilize output after years of decline. Although these are probably not going to run out so quickly as some alarmists claim, the low hanging fruit won't last forever.

Finally there is the issue of Pemex's union, the notoriously militant STPRM, led by none other than a PRI senator, Romero Deschamps. Mr Peña Nieto has had to tread carefully, avoiding any mention of the union in the reform proposal. This may be a shrewd political maneuver for the time being, but it gives little comfort to those who see the union as one of the reasons that Pemex has failed to modernize, and who hope that the reform erodes their influence in the same way the education reform weakened the sector's stranglehold by the SNTE (the teachers' union).

What the real debate should be

In an ideal world, the debate on energy reform should focus on setting a concrete and achievable road map for Pemex's modernization, as well as defining the limits of the union's influence. It should ideally be debated after the fiscal reform has been approved, as only the latter will guarantee that the energy reform will succeed in all of its objectives. As it is, the reform is the first in Peña Nieto's agenda which has fallen slightly short of the mark.

But no matter how close to ideal the reform could have been, any debate on oil in Mexico is destined to be anything but reasoned. The left, as is expected, will denounce the perceived attempt to "privatize" Pemex when nothing remotely of the sort is contemplated. It will fight against any form of competition in the energy market (refining, transportation, electricity generation) despite the obvious contradiction of demanding more of it in telecoms and the media. And in doing this, it will indirectly support a status quo that any sensible Mexican regardless of ideology should find repugnant: Pemex as an inefficient and monolithic government firm, trapped in the straitjacket of its fiscal regime and its militant union. When it all comes to a vote, however, joint PRI and PAN support for energy sector liberalization will tilt the cards in favor of the reform, regardless of how many of Mexico City's boulevards are shut down by AMLO's protests.

Perhaps some consolation for the discontents can be found in the fact that most foreign investors actually found the energy reform to be rather disappointing: no concessions, only partnerships allowed. Surely a reform that failed to win over the market can't be that bad, can it?

EIU Latin America on Twitter: @TheEIU_LatAm