Pemex Finally Enters the Modern World?

In the Palacio Nacional in Mexico City there is a mural by the artist Diego Rivera, chronicling a history of the exploitation of Mexico by outsiders – first the conquistadors, and more recently, foreign mining and oil companies, among others.  Yet now, despite Mexicans’ deeply ingrained cultural sense of exploitation by investor-owned oil companies (IOCs), it appears that Mexico is on the verge of reversing its constitutional prohibition against the participation by private companies in Mexico’s oil and gas markets.

Because of that prohibition, Mexico has mostly missed out on the oil booms of the post-OPEC era.  The national oil company, Pemex, controls oil and gas development in Mexico.  Pemex does not partner with IOCs like ExxonMobil, Shell and BP the way Petrobras, Statoil, and other national oil companies (NOCs) do.  Other NOCs use partnerships with IOCs to attract capital for — and share the risk of — exploration and production; they also use partnerships to siphon experience and technical know-how from the IOCs over time.  Pemex does none of this.

Furthermore, large chunks of its revenue are diverted to the government budget rather than reinvested in the business. Consequently, Pemex has under-invested in exploration and development, and has become a focal point for patronage and corruption.  One need look no further than the Mexico-US border for evidence of Pemex’s missed opportunities. On the American side of the western Gulf of Mexico lie state-of-the-art production platforms producing oil and gas from deep water reservoirs. Not so on the Mexican side.  Onshore, the Eagle Ford Shale, a rich source of unconventional oil and gas, hums with production activity on the American side of the border, but not the Mexican side.

Prognosticators say that President Enrique Pena Nieto and the ruling PRI party (with the support of the PAN, one of the other two major political parties) may finally be able undo the constitutional bar to private development that the PRI government created so many decades ago. If so, that will be only the first step of a long walk for Pemex.

Having worked with IOCs and NOCs over the last ten years on stakeholder and corporate social responsibility issues, I have learned that the partnership between NOCs and IOCs is a complicated, delicate dance, in which the allocation of risks and rewards is the subject of continual contention and negotiation.  Contracts establish the broad boundaries of the relationship, but the dance plays out in countless venues over many years — even decades.  Managed correctly, partnering with IOCs offers an opportunity for countries like Mexico to enlarge the pie – to discover and share mineral riches that would not have been discovered otherwise.  But managing that process correctly is an enormous challenge.

On the one hand, if the rewards for IOCs are too few, IOCs will be unwilling to assume financial risks and share expertise with Pemex.  Right now in Brazil we see Petrobras struggling to calibrate the risk-reward incentives for IOCs correctly.  Its recent auction for rights to partner with Petrobras to develop vast but technically challenging “pre-salt” deposits attracted only one bid (and no interest from American IOCs), a problem which some attribute to new and more onerous tender offer terms.

On the other hand, Mexicans fear (with some justification) that the benefits of increased oil and gas production will accrue only to a privileged few, or mostly to foreign IOCs. It doesn’t matter how large the pie gets if most people never get to taste it.  In economic terms, increased oil and gas exploration that produces additional wealth for Mexico increases social welfare (assuming no environmental or other harm is done), even if most of the wealth accrues to a privileged few.  But in political terms, inequality matters.

It is a variant of the so-called “divide the dollar” game (a/k/a the “ultimatum game”) in which two people are presented with an opportunity to divide the proceeds of a dollar that is given to them by the experimenter.  The rules specify that the first player decides how the dollar will be split between the two players (e.g., $.50 for you, $.50 for me; or, $.90 for me, $.10 for you, etc.). The second player can then accept the deal, in which case the money is distributed to the players as specified by the first player; alternatively, the second player can reject the deal, in which case the experimenter keeps the dollar. A rational, self-interested second player ought to accept any division of the dollar that increases his or her wealth, even by one penny. Yet most players reject allocations that seem too unfair, even if it means forgoing the (seemingly maldistributed) financial benefit.

National governments, human rights groups, IOCs, and others have devoted considerable attention over the years to the problem of reducing corruption and ensuring that oil and gas royalties benefit the broader host communities. In some places those efforts have borne fruit, while in others significant challenges remain.  Host countries and NOCs have gained leverage over IOCs over the last few decades, imposing tougher royalty and tax regimes on foreign investors.  But in order to make that leverage work for their people, host governments and NOCs need experience partnering with IOCs and managing the royalties they pay.

Pemex has been absent from this process.  They are starting at square one.  (Given the reputed levels of corruption within Pemex, perhaps they are starting at square negative one.)  It will take a sustained and committed effort by the Mexican government over time to create the institutional environment in which (i) Pemex can partner effectively with IOCs, and begin to reap the technical and management benefits of those partnerships, and (ii) the economic and other benefits of oil and gas development can be broadly shared by the Mexican people.

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