Mexico's energy sector awaits AMLO's next move

Mexico's new President Andres Manuel Lopez Obrador has vowed to lead his country through its fourth transformation, following colonial independence, 19th century liberal reform and the 1910 revolution.

The country's energy transformation ushered in by his predecessor Enrique Pena Nieto in 2014 — regarded internationally as one of the most sweeping such reforms in decades — did not make his list.

Whether AMLO, as he is known, will continue to tolerate the energy reform continues to be the main question after the new president took office on 1 December, blasting what he said he consider a failed reform in his inaugural speech.

His Morena party won control of both houses of Mexico's Congress in the same 1 July election that was a landslide for AMLO, giving him a strong mandate to start his six-year term.

Upstream intermission

Uncertainty has characterized the planned policy for upstream in the past five months.

AMLO pledged again in his inaugural speech to honor existing contracts awarded during the upstream auctions managed by oil regulator CNH. But he sent a clear message to private sector companies during a meeting with oil majors in September: start producing more or the government will rethink the strategy.

Since 2014, CNH has conducted three major upstream rounds for onshore and offshore blocks as well as three farm-outs in which Pemex partnered with the private sector to develop acreage awarded under the reform.

The tenders have resulted in more than 100 contracts signed by 73 companies that, if all licenses prove viable, will reach investment of $161bn, according to CNH.

Following months of speculation, incoming energy minister Rocio Nahle confirmed last week that future upstream auctions, including shale and conventional auctions scheduled for next February, will be suspended for at least two years. She also appointed an undersecretary with no energy background who has opposed the reform, but also awarded other posts to people with more technical backgrounds.

AMLO has pledged to increase oil production from 1.7mn b/d to 2.6mn b/d by the end of his administration in 2024.

The administration has vowed to boost activity at Pemex, yet whether Pemex will have the budget for increased drilling activities remains unclear. The proposed 2019 drilling and production budget is Ps75bn ($3.9bn), just 44pc of this year's E&P budget. The budget, to be approved by Congress by the end of the year, will be crucial for determining viability of these plans.

Members of AMLO's team have expressed support for additional farm-outs if Pemex is allowed to pick its own partner. It is unclear what type of blocks might be selected as AMLO again during his inaugural address ruled out hydraulic fracturing for potential shale exploration in northern Mexico seen by many as critical.

Long-time Mexico energy consultant George Baker, who attended the inauguration, noted that determining what is needed for well development falls under the authority of the CNH.

"The president really has no direct jurisdiction over the fracking of wells," Baker said. Overruling the CNH on the matter "speaks badly for the independence of regulatory institutions."

Fuel price focus

Gasoline and diesel prices which have risen along with international market — and remain far above prices in the US — were a rallying point for AMLO's campaign.

But fulfilling a campaign pledge to reduce fuel prices would cut into funds needed to fulfill other promises for social spending, and even to turn around falling output of refined products.

Yet as soon as 7 December, with the weekly publication of the IEPS deductions, a key sign of the fuel price strategy will be public. Higher deductions would have an inverse effect on both final retail prices, and government coffers.

The second sign of the administration's fuel price strategy, the base level of IEPS tax for 2019 — if there is to be one — will be set by late December in the federal budget. Final publication in the official gazette would come on 4 January.

IEPS taxes from gasoline and diesel gathered by Mexico's finance ministry in September, the last data available, were roughly Ps15bn ($739mn) or 3.4pc of the total taxes received by the government that month.

Ten months of income from the IEPS would almost equal the budget needed for a promised, but financially and technically challenging, new refinery in Campeche, which the government says it can build for Ps160bn ($8bn).

Gas and power in the background

The incoming administration has been mostly silent on natural gas.

With the latest tender suspensions, Pemex will likely bear the burden of increasing national gas production with its new discoveries as well as improving output from some existing fields.

Natural gas is among Lopez Obrador's greatest challenges, given Pemex's declining production and Mexico's aims to transition heavily to gas-fired generation. Industries in the southeastern region of Mexico have complained of gas shortages this year.

Pipeline projects in the works to increase import capacity from the US to some 11 Bcf/d to meet the actual 7.7 Bcf/d demand — mostly driven by the northeast and south-southeast regions at 2.5 Bcf/d each — also represent a short-term challenge.

The appointment of lawmaker Manuel Bartlett to head Mexico's state-owned power company CFE signals a will for greater government control in power matters.

Analysts expect gas consumption by CFE could also shift again under the new administration back some to fuel oil and diesel to free up natural gas for other consumers, particularly industrial ones.

Lopez Obrador's has also discussed reverting to some coal use for generation, while also focusing on hydropower, characterizing what have been divergent and conflicting indicators of policy to come.