The alleged transition from partners to neighbours – US and Mexico 2017

February 2017 | EXPERT BRIEFING | SECTOR ANALYSIS

financierworldwide.com

In December 2013 Mexico was energised by a widespread structural and constitutional reform which initiated the so called ‘Mexican energy reform’. This change of paradigm aimed to update the country after nearly eight decades of state monopolies in the oil & gas space.

The energy reform promoted openness to private investment and attracted the attention of both local and foreign stakeholders who hoped to explore the emergent opportunities for private ventures in activities which had been traditionally reserved for Mexican state-owned entities.

Two years after its implementation, the framework seemed renewed, regardless of the volatility of the markets and the challenges that such an overhaul represented for one of the most protected energy markets in the world. Upon its third anniversary, the energy reform faces an unpopular increase in the prices of gasoline and power to the general population, accompanied by the devaluation of the peso against the US dollar. Both of these circumstances were intimately related to the outcome in the recent US presidential elections.

President Donald J. Trump’s win last November has diminished the positive framework for international trade between neighbours and the flow of American direct investment into Mexico, which were two pillars of the successful transition needed to help achieve the objectives of the energy reform. The reform hoped to provide a number of direct benefits to many Mexican families and individuals by increasing competition, increasing the availability of commodities and creating 3 million new jobs by 2025.

The opening of the energy market in Mexico was indicative of a growing dependence on the US, particularly in terms of importing products such as gasoline and diesel. During the first half of 2016, imports of natural gas from the US reached historic levels, with an increase of 32 percent compared to 2015. There was also a 21 percent increase in refined imports during the same period.

Donald Trump faces a Mexico that relies on American energy resources and refining systems more than ever before. The general discourse during his campaign, as well as his staff and advisory appointments since winning the election, have suggested he will pursue tough renegotiations of trade conditions with Mexico, alongside apparent protectionist measures to maintain direct investment within the US. The time for speculation on the future relationships between these long-term trade partners came to an end on 20 January. The campaign promises of the Trump economic package and the strength of the new policies of the energy reform are now being tested.

From imports to exports – energy sufficiency of the US

In recent years, the technique known as ‘fracking’ has made the US the world’s leading producer of gas, taking the country above its long-time competitor Russia. Experts predict that the rising consumption of natural gas will be met by the increasing production from shale basins and a fading need for oil imports over the next two decades. Alongside increased refining capacity, these projections allowed the US to abandon its imports of 1 million barrels per day (bpd) of refined products to become a growing exporter of 2 million bpd. The US is expected to reach energy independence by 2035, while current data suggests that the country is currently at 75 percent independence. As it is approaching its self-sufficiency, the US’ export restrictions have become increasingly flexible, mainly in natural gas, fuels and also in crude oil. Mexico has emerged as a natural customer of US exports.

Since 2008, oil production from fracking has grown from 600,000 bpd to 3.5 million bpd – an increase in total production of 30 percent. In 2012, the US extracted 8.9 million bpd, approaching the 10.6 million of Russia and 11.5 million of Saudi Arabia. While in proven oil reserves the Middle East continues to concentrate the largest amount, by the end of last year US oil production reached 7.74 million bpd, surpassing crude imports for the first time in many years and making it the second largest producer country in the world.

Available resources, innovation, flexibility to incorporate new technologies, increased exploration and production and expert forecasts seem to encourage the predictions of continued American expansion.

Mexico’s open market – the organic off-taker

As a result of the energy reform, Mexican public policy was realigned in order to promote a competitive market of power generation and liquid fuels, by limiting the dominant power of state-owned productive enterprises and establishing incentives to encourage private parties, either domestic or foreign, to invest in Mexico’s electric and hydrocarbons industry. Different government agencies are encouraging the entrance of new economic agents into the market that will enable the efficient development of both the energy sector and the Mexican market, by facilitating the access to locally-controlled infrastructure, incentivising foreign direct investment in the construction of power plants and transmission lines, pipelines and storage facilities for fossil fuels, and granting import permits for refined products for volumes that exceed the current demand.

Mexico’s energy reform is buttressed by new infrastructure, mostly financed by private entities and local and foreign banks. Considering the natural off-take of the American commodities sector, four new transnational pipelines have been constructed across the US-Mexico border, enabling the trading machinery to grow.

Additionally, the new legal framework represents an area of opportunity to promote an intertwined electric system. Unlike Canada, Mexico is not widely interconnected to the US power system; however, the new policies allow the import of power that could be implemented by the installation of transnational infrastructure between the southern states of the US and the northern region of Mexico, where customers pay twice as much compared to their American counterparts.

The energy reform has increased the inflow of foreign direct investment in Mexico. The entrance of foreign capital in energy related business interests broke its national record during 2015, led by the generation, transmission and distribution of electric power, with an inflow of $594.2m, and pipeline transportation of gas worth $543m. The Mexican government expects this foreign interest to continue to grow.

Current grounds – treaty and commercial regime among neighbours

Mexico and the US are subject to a treaty-regime structure that prevents them from implementing discriminatory provisions to trade and investment. The North America Free Trade Agreement (NAFTA), now under revision by Mr Trump’s administration, provides for a balance of tariffs and taxes applicable to trade between Mexico, the US and Canada. However, this is not the only treaty-based control mechanism that could maintain the trading flow of commodities among these countries. They shall maintain reasonable commercial limitations based on the compromises achieved on GATT and WTO, which would eventually allow Mexico to continue importing fuel into its territory without additional discriminatory restrictions, even if NAFTA suffers a disadvantageous renegotiation, as promised by President Trump during his campaign, or an abrupt early termination by the US Congress, now controlled by the Republican party.

Careless decisions around the future relationship with Mexico may cause the Trump administration to damage the relationship with the largest buyer of US gasoline – Mexico consumes 60 percent of the US’ total exports, 300,000 bpd above the Dominican Republic, a distant runner up. Mexico’s daily need of imported fuels does not allow a flexible timeline for renegotiation of new trade conditions, forcing it to look for supply alternatives in Europe and Latin America.

If the new US government prevents the organic flow of foreign direct investment into Mexico and abroad, it could negatively affect the country’s electric power market which achieved exports worth $10.18bn to Mexico in 2016.

In addition to the international treaties, any attempts to block the growth of this energy-based interrelationship should be discouraged on commercial grounds. The immediacy between the area of production to the consumer market, just across the border, argues in favour of president Trump’s expansion plans at the time it continues vindicating the energy reform: the US necessitates a consumer like Mexico, increasingly interconnected with the southern regions of the country and undergoing a deregulation process that indicates an openness to capital and commodities in an emerging market.

Diana María Pineda Esteban is a senior associate and Jacqueline Pasquel González is a junior associate at González Calvillo, S.C. Ms Pineda can be contacted on +52 (55) 5202 7622 or by email: dpineda@gcsc.com.mx. Ms Pasquel can be contacted on +52(55) 5202 7622 or by email: jpasquel@gcsc.com.mx.

Diana María Pineda Esteban and Jacqueline Pasquel González

González Calvillo, S.C.