Mexico on alert over falling oil prices

A dark cloud is hanging over Mexico’s economic horizon. Just when President Enrique Peña Nieto had completed an energy reform ending a 76-year oil monopoly and was getting ready to open up the doors to foreign investment, the price of crude suddenly plunged.

In just four months, the price of a barrel has dropped 25 percent, from $102 to $75, with a marked acceleration these last few weeks.

Oil is the cornerstone of Mexico’s finances. The country is the third-largest producer in the Americas, and it depends on oil exports for its economic survival. Around 30 percent of the state’s revenues come from oil, and a strong, sustained price variation could hurt the economy just as it is trying to take off.

Besides issuing multiple messages of calm, the government has chosen to be realistic and this week reduced the estimated price of a barrel to $79, three dollars less than what is reflected in the 2015 budget. If this amendment is not countered through the exchange rate, it will mean nearly a billion dollars less in revenues for next year, say the experts.

Around 30 percent of the state’s revenues come from oil, and a strong, sustained price variation could hurt the economy”

This would be a serious setback for an economy that depends on public spending to grow at its target rate of five percent of GDP.

The international scenario does not help. Goldman Sachs has forecast a general drop in crude prices for 2015; the Chinese economy, a traditional devourer of oil, is stagnating; US oil reserves are above expectations, and OPEC has decided to keep up current production rates despite pressure from Venezuela to slow the flow.

Given the surplus of available petroleum, it is difficult to imagine prices recovering and remaining high.

“The only advantage to this drop is greater growth in the US, which would be good for Mexican exports. But there is a clear risk to the public finances,” says Arnoldo López Marmolejo, chief economist at the analysis division of BBVA-Bancomer.

But state revenues are not the only victims of lower oil prices. Foreign investment is another one, as low prices dissuade investors from pouring money into projects where exploitation costs are higher and margins lower. And this, at a time when Mexico desperately needs private capital.

Mexico has to be competitive with regard to other opportunities in the world”

Mark Albers, vice-president of Exxon Mobil

“The problem with falling oil prices just ahead of the energy aperture is that it reduces the government’s leeway for negotiation. At the same time, businesses are cutting back on their projects because they are afraid of entering a new market with these uncertainties,” says Miriam Grunstein, a researcher and lecturer at CIDE (Centro de Investigación y Docencia Económicas).

For companies eying the nascent Mexican market, there is one way to counterbalance these falling prices: reduced fiscal costs. This tool is in the hands of the Mexican executive, which sets the contracts with the multinationals and the conditions.

“Mexico has to be competitive with regard to other opportunities in the world,” warned Mark Albers, vice-president of Exxon Mobil.

But lower taxes means reducing state revenues, which is exactly the opposite of what the energy reform seeks.

The dismal situation in which Pemex finds itself only makes matters worse. The state-owned oil company has accumulated losses of $12 billion in the first nine months of the year, its production is down, and so are its exports.

The humiliating possibility of having to import a massive amount of barrels has already been mentioned in the national media, though quickly denied. Oil imports are already a reality in another Latin American oil producer in trouble, Venezuela.

For two years, foreign capital and its beneficial effects have been the linchpin of the Mexican government’s economic program. A setback would have serious political consequences. Elections are coming up next year, and scandals such as the case of the missing college students from Iguala have brought citizen confidence to an all-time low.

“Next year is going to clear up many issues,” says Grunstein. “The market will ultimately decide on the bidding by saying yes or no to the contracts. Let us hope everything goes well, or it will be disastrous for Mexico.”