The Real Deal

In one of his famous stories, Sherlock Holmes solves the riddle because of the dog that didn’t bark. That was the abnormality that evidenced the criminal. I am no expert on energy matters, but over the past several months, I have devoted myself to reading and listening to experts who know what they’re talking about and from whom I have learned the rules and basic requisites that must be satisfied for an energy reform to have a reasonable chance to achieve the objective of attracting capital, developing the sector and constructing an additional platform –a powerful one- for the growth of Mexico’s economy. In a way, I have attempted to identify why the dog didn’t bark in the Mexican energy conundrum. What I’ve found won’t delight the country’s politicians.
I start with the analysis of an expert of the Inter-American Development Bank (IDB). His focus is Latin-American and absolutely analytical: to be exact, he doesn’t care about the nationalistic or political criteria involved; his sole interest is to evaluate the results of the strategies that take shape in the law that distinct nations of the continent have adopted to develop their energy resources. He inquires into, on the one hand, the rules of the game that each nation has established and, on the other, observes the work and the results produced by two decades of industry performance, country by country. This expert sums up his conclusion by grouping the Latin-American nations into two tiers: successful and failed. The measure of success or failure is very simple: the growth of the industry and its capacity to contribute to the development of each country’s economy. In the first group, that of the winners, he finds Peru and Colombia. In the group of the losers he finds Venezuela, Ecuador, Argentina, and Mexico. Brazil was one of the winners up to a couple of years ago when it began changing the rules of the game, thus insisting on being a loser.
The big question is: what is the critical difference? In a word, Ramón Espinasa, the IDB expert, says that the difference lies in the nature of the regulations and the strength of the regulator. Where the regulations are designed to promote the development of the industry, it prospers; where the regulations confound or undertake contradictory objectives the result is disastrous. Nothing better illustrates the situation than the case of Brazil: the first wave of reforms, in the nineties, pledged to create a true energy market in which the main actor, Petrobras, the Brazilian energy corporation, was conceived as primus inter pares, that is, as the privileged actor but not as the factotum of the industry. The first legislation granted neither privileges nor perks to the governmental oil company. That fact made it possible for diverse actors, foreign and domestic, to become interested in participating in the industry and to bid for contracts that the Brazilian government put on the market. However, in recent years the government modified the legislation, incorporating into it a series of criteria that clash with the former logic: now it demands that local content be part of the bidding process and that contracts be framed in partnership with Petrobras. That is, the new legislation procures governmental control of the industry. The result has been that none of the relevant actors worldwide –relevant above all because they have the technology and capital that the Brazilians (and Mexico) lack- has been interested in participating. That’s why Brazil has stopped belonging to the group of successful nations. The situation would be even worse for Mexico were it to require new investors to contract with the Pemex union.
If the objective is to attract investment and technology, the legislation must respond to the market characteristics, that is, it has to be competitive with respect to other nations that are also desirous of developing their hydrocarbons. However, Mexico’s focus has been exactly the opposite: the point of departure is that the rest of the world lusts after exploiting its potential oil and gas resources and the only thing the country has to do is roll out the welcome mat.  It is possible that this focus would have been viable ten years ago when the oil world was experiencing a pessimistic time and any opportunity seemed attractive, a moment known as “peak oil”. The situation changed drastically with the discovery of new fields and, above all, with the development of novel technologies that led to the shale oil and gas revolution.
The new world of energy, in which Mexico’s chief client will be self-sufficient, entails a competitive rationale –in fact, a buyers’ market, dissimilar to anything known in recent decades. In the words of one of the best known executives in the oil business, “Today there are numberless projects in the world and what’s in short supply is capital”. That is, the great actors on the planet will evaluate their investments contingent upon two factors: their potential profitability and the legal certainty that each nation offers. Profitability depends on technical (costs and risk) as well as regulatory factors. Certainty depends on the legal regime under which these must operate. Under present-day circumstances, no company of consequence would participate in a project that did not guarantee an attractive return and the certainty of no political interference in the development of its investment. More importantly, the calculation that they will make is not in reference to Mexico but rather to the entire ensemble of options and opportunities in its prospective portfolio. To be precise, when Mexico publishes a new regime on energy matters it will be competing with Vietnam, Cuba, Russia, Indonesia and the US itself: in other words, with the rest of the world. In all of this, the referendum that the left is demanding would entail an additional –enormous- cost and risk, further delaying any potential investment.
All this implies only one thing: Mexico had better create a truly competitive regime that would attract important and relevant players worldwide or stop wasting time. It is obvious that the big players will demand any number of conditions before a new regime is legislated although, at the end of the day, they could probably live with something less ambitious; but there’s no way of knowing until it happens. The evaluation performed by the investors that the government wants to attract will be ex post facto. It is then that the true verdict on the reform will be rendered. Were the legislation to be insufficient, the result would be a disaster.
From my learning I am able to say that, beyond the strictly technical, the crucial difference lies in three factors: a) the (real) independence of the regulator as the ultimate authority; b) the inexistence of absurd requisites such as partnership with Pemex or local content; and c) the development of an energy market that allows the players in the industry to operate by market ̵ as opposed to political- criteria. What’s riding on this is, in a word, EVERYTHING.