Cracking the Door on Mexican Oil

Since his election last year, Mexican President Peña Nieto has been pushing a strong reformist agenda through his country’s Congress, notably the liberalization of Mexico’s energy patch.

Since nationalizing the industry in the 1930s, the Mexican government has keep its energy sector well-fenced against foreign incursion after decades of what it perceived as exploitation of the country’s resources. But left in the hands of the state-run monopoly known as Petroleos Mexicanos (Pemex), the country’s energy production has been steadily falling, largely thanks to underinvestment. Over the past decade alone, Pemex’s crude oil production has fall from 3.4 million barrels per day (bbl/d) to just 2.5 million bbl/d in October, a 25 percent decline.

This decline in oil production has cast a huge pall over Mexican prosperity. The country’s government has used proceeds from Pemex to finance many aspects of its operations; as goes Pemex, so goes the national economy. That is also why there has been such a sharp drop in production in recent years—rather than recycle oil revenue into much needed capital investments in energy infrastructure, the public sector bureaucracy has siphoned off funds for other uses, many of them inefficient. In fact, Pemex is the source of more than a third of the government’s revenue.

This chronic underinvestment has become even more of a challenge, as reserves of easy-to-produce onshore oil dwindle and, to boost production, Pemex must turn its attention to offshore assets in the Gulf of Mexico. While private companies have been drilling in the Gulf for decades, Pemex has virtually no experience in deepwater drilling and production. But it estimates that as much as 29 billion barrels of recoverable oil lie beneath its part of the Gulf of Mexico.

To remedy these woes, the Mexican Senate yesterday approved an energy bill that should s! pur growth in the region’s second-largest economy and will likely take Mexico from being the world’s ninth-largest oil producer to the fifth over the next 10 years. If this legislation eventually passes the lower house, the Chamber of Deputies, production will likely rise to 4 million bbl/d by the end of the next decade, which would make Mexico a larger oil producer than Canada.

More than 20 hours of Senate debate played out like a lurid Mexican telenovela, as parties that oppose the bill draped banners across the Senate chamber, chanted, and sang the national anthem. At one point, fisticuffs broke out. In the end, the Senate proposed a constitutional amendment that would pave the way for production sharing and licensing for foreign energy companies, which will also be allowed to book reserves for accounting purposes.

The proposal would remove all representatives of the Pemex workers’ unions from the company’s board of directors, taking it down from 15 members to a much more streamlined 10.

Easing those restrictions is expected to unleash a wave of international exploration efforts in the country, assuming the Chamber of Deputies approves the measure. A vote in that body is expected as early as today. However, a measure was introduced in that chamber that called for a national vote on the privatization program in 2015, while the Senate version would allow for the constitution to be amended with a two-thirds vote in both chambers.

Assuming the privatization plan clears this last hurdle (our guess is that it will), Mexico’s Finance Ministry estimates that the increase in production would boost the country’s gross domestic product (GDP) by 1 percent by 2018, much needed growth after this year’s estimated GDP growth of a meager 1.3 percent. Analysts at Barclay’s project that energy investment would grow to 3.5 percent of GDP, up from less than 2 percent today.

In addition to being a boon for the Mexican government and people,! the meas! ure’s passage would be a major plus for companies such as Chevron (NYSE: CVX), which haven’t been able to drill in Mexico since 1938. In the meantime, though, Chevron has been operating in Latin America for more than 90 years, conducting exploration and production in countries such as Argentina, Brazil, Colombia and a number of others. Chevron rates a buy up to 130 on its own merits, as well as a play on Mexico’s liberalization of its energy patch.

Another major beneficiary of liberalization would be Keppel Corp (OTC: KPELY), which has already signed a memorandum of understanding with Pemex to develop, own and operate a yard facility in Mexico.

The deal is consistent with Keppel’s strategy of maintaining construction capability as close to customers as possible. Keppel already has snagged orders to construct six KFELS B class jackup rigs for Pemex and its order book will only grow with the entry of foreign energy companies. Keppel Corp is a buy up to 20.